INVESTMENT LAW

1ST INTERNAL ASST.

2ND YEAR LLB

CROWD-FUNDING BY
ISHITA AGRAWAL

REGULATORY 19010122096

FRAMEWORK MAHIMA SHARMA

19010122097
 CROWDFUNDING - INTRODUCTION

Crowdfunding is solicitation of funds (small amount) by entrepreneurs or

business from multiple investors through a web-based platform or social
networking site for a specific project, business venture or social cause.
Area of Focus: Indian startups, SME’S, social cause.
• Started in 1997, Marillion, british rock group, raised U.S $60,000 in
donations by fan-based internet campaign.
• Father of crowdfunding, Brian Camelio, started CFP’s for artists and
raised funds for 10 Grammy winning music awards.
Indian Scenario
• In 2012, a successful year, Wishberry followed by Kitto and Milap
and in 2015, Impact guru, were launched.
• In 2013, first ever crowdfunding regional film, Lucia raised Rs. 51
Lakh in just 10 days through Facebook page and a blog.
• Dhirubhai Ambani’s textile business was crowdfunded by communities
across Gujrat.
CROWDFUNDING
MODEL
 HOW DOES IT WORK?

• PITCH- idea or project with fundraising targets or milestone.

• Screening- the “platform” (website used) will screen the pitch
before it goes live.
• Pitch Goes Live- gets a webpage that includes project details,
targets, fundraising deadlines, any rewards, amount raised so
far etc.
• Money Pledged by Public- Funding is received according to
the model opted for i.e. either “All or Nothing” / “Keep It All”.
• Project Development- Distribution of rewards promised to
offer the public.
 TYPES OF CROWDFUNDING

 General statutes such as the Income Tax Act, 1961, The Foreign Contribution (Regulation) Act, 2010
(FCRA) and the Foreign Exchange Management Act, 1999 (FEMA) applies to all types of crowdfunding .
 COMMUNITY CROWDFUNDING
DONATION BASED REWARD BASED
CROWDFUNDING CROWDFUNDING
 Solicitation of funds for social, artistic,  Solicitation of funds from investors in
philanthropic or other purpose, and not in exchange for existing or future tangible
exchange for anything of tangible value. rewards
 Area of focus: Social causes.  Three Categories:
 No yield or returns on investment Pre orders, Services and Recognition.
 No minimum or maximum amount for  Area of Focus: Small Entrepreneurs, Free
donation. software development companies, creative &
innovative projects.
 Service Fees : 5 -10%
 Examples: Wishberry,
 Example: Milaap, Rocket fund, Impact Guru,
Crowd funder, etc.
 Indiegogo and Kickstarter (largest)- run at least
4,00,000 projects including “Potato Salad.
 FINANCIAL RETURN
CROWDFUNDING
PEER TO PEER LENDING / EQUITY BASED
DEBT BASED CROWDFUNDING

 Also known as “Direct Consumer Lending”  It refers to fund raising by a business,

particularly early-stage funding, through
 An online platform matches lenders/investors
offering equity interests in the business to
with borrowers/issuers in order to provide
investors online.
unsecured loans and the interest rate is set by
the platform.  SEBI has called out laws on digital equity
crowdfunding as unauthorized, illegal and
 Regulated by RBI under NBFC-P2P licence.
unregulated.
 To meet short-term requirements.  Area of focus : Small entrepreneurs, early
 Examples: Lending club in U.S, Zopa in U.K, stage companies.
i2i Funding, LenDenclub etc in India.  Mostly prevalent in U.S and U.K
 For example: Syndicate Room , Crowd cube,
gust, Fundable etc.
 WHY IS CROWDFUNDING PREFERRED?
 Alternate source of funding and allows increased flow of credit to start-ups, SME sectors, and other users.

 Validation of Concept – An excellent opportunity to present the business / project to masses.

 Assists SMEs to raise funds at a lower cost and through a simpler procedure as compared to other modes.

 Efficiency- The platforms ability to centralize and streamline the fundraising effort will result in ample time for the borrower
to run the business.

 PR &Marketing- Promotion and campaign opportunities through social media and other marketing tactics.

 Presentation- Creation of crowdfunding campaign helps in reviewing the business and polish it better.

 Due Diligence and vetting of the projects hosted on the platform’s website to maintain their reputation.

 Networking- Enables borrowers to reach to wide range of investors that are beyond personal connections.

 Encouragement in growth of SME’s and boost in country’s economy.

RISKS INVOLVED IN
CROWDFUNDING

Risk of Default: Inadequate recourse available in case of temporary or permanent shut down
due to overdue maintenance or hacking. Ex: Quackle.
Risk of Fraud: Possibility of genuine website being used by fraudsters and false websites
being established leading to risk of cyber security and identity theft.
Risk of Failure: High failure risk as funds raised by early stage companies or ventures
depend on future possibilities . Ex: Bubble and Balm, a fair trade soap company.
Information Asymmetry: Certain investors may have access to information which is not
available to others. No stringent obligations on reporting and transparency leading to
misrepresentations.
Systemic Risk: Secondary market not available for investors causing a risk of low liquidity.
 CONSULTATION PAPER ON
CROWDFUNDING - SEBI
 1) Access to Market and Eligibility
 2) Accreditation of Investors and
of Fundraisers. Investment Limits.
 Size of issue not exceed Rs. 10 Crores.  Participation Restricted to Accredited investors.
 Not promoted, sponsored or related to an QIB’s – more than 5% of securities.
industrial group with turnover more than Rs. Companies with minimum net worth 20 Crores and 4x times
25 Crores or having an established business. offer value. HNI’s with
min. net worth 2 Crores and 3x times
 Unlisted and less than 48 months old.
 Not engaged to real estate or policies
 Eligible Retail investors –min : 20,000 and max: Rs.
prohibited under India’s Industrial Policy .
60,000.
 Directors, Promoters and Associates not Min annual gross income 10 lakh.
declared as “defaulter” by RBI / CIBIL and Filed income tax return for min 3 preceding financial years.
not prohibited from accessing capital market.
Well advised and passed an appropriateness test.
 CONSULTATION PAPER ON
CROWDFUNDING - SEBI

3) Regulation of Portals 4) Procedure and Disclosure Requirements

 Platform categorized into 3 kinds.  Procedure requires the company’s details be

i. Class I Entities- Recognized Stock Exchanges with nationwide displayed on website and circulate a private
terminal presence (RSEs) and SEBI registered Depositories. placement offer letter to the interested investors.
ii. Class II Entities - Technology Business Incubators (TBIs);  Companies are required to circulate information
registered as society or non-profit company - at least 5 years
similar to private placement under Companies Act,
old and minimum net worth of INR 100 million.
2013.
iii. Class III Entities- Associations and Networks of PE or Angel
Investors, registered as a non-profit corporation;  These disclosures include:

 Name of the company, registered office address,

Minimum: paid up share capital = INR 20 million,
Track record = 3 years, Strength= 100 active members. history of funding, financial condition of company,
ownership details and capital structure, etc.
 LOOPHOLES OF CONSULTATION PAPER
 Restricted to accredited and retail investors:
 Unwillingness of accredited and retail investors to use crowdfunding platforms.
 Increased chances of failure.
 Removal of “crowd” from crowdfunding.
 A cumbersome process imposed on the issuing company.
 No Fee Structure: It is crucial for targeted entities to analyse the capital raising cost.
 No Secondary Market for Equity Crowdfunding:
 Through Buy-back of securities under CompanieAct,2013.
 To another accredited investor.
 To a family member or relative or friend of the existing investor.
 Classification of Entities: Prevents business from developing and curb donation or reward based platforms to run equity based crowd
funding campaigns.
 Increased cost and Reduces Efficacy: Proposed procedural requirements, due diligence and background and regulatory check for the
investors holding above 20% equity .
 Skipped the issue of Cross- Border Crowdfunding.
 EQUITY CROWDFUNDING:
LEGAL OR ILLEGAL?
ANALYSIS: SAHARA CASE
(Sahara India Real Estate Corporation Ltd. & Ors. v. Securities Exchange Board of India & Anr)

FACTS:
Two unlisted companies, SIRCL and SHICL, raised funds over USD 3 billion from nearly 30 million investors by
issuing OFCD’s and distributing information memorandum through approximately a million agents and three
thousand branch offices to more than specifically to and/or friends, associated group companies, workers/employees
and other individuals associated with Sahara Group were eligible to apply for the issue of these OFCDs.
ISSUE:
Whether the OFCDs issued by the companies were by way of “private placement”- as claimed by the Sahara
Companies on appeal, or by way of an invitation “to the public” - as counter claimed by the SEBI?
JUDGEMENT:
Supreme court observed that it was in violation of securities regulations and must refund the amount to investors and
to insure refund the chief of sahara groups was arrested.
AFTERMATH:

Section 42(2), Explanation I –

If a company, listed or unlisted, makes an
 Ministry of Corporate Affairs introduced a new provision
offer to allot or invites subscription, or
in the then Companies Bill 2011 (enacted in 2013). The
Companies Bill 2011 was scheduled to replace the earlier allots, or enters into an agreement to
Companies Act of 1956 and inserted Section 42(2) , allot, securities to more than the
explanation 1. prescribed number of persons, whether
the payment for the securities has been
 Section 42 (1) & (2): private placement be offered through received or not or whether the company
private placement offer letter. intends to list its securities or not on any
 Limits investors who can issue shares up to 50 members recognized stock exchange in or outside
and who can make offer for issue of shares up to 200 India, the same shall be deemed to be an
members in a financial year, excluding QIB’s and offer to the public and shall accordingly
employees. be governed by the provisions of Part I of
this Chapter.
SEBI’s APPROACH

Investor Caution Notice (2016)- On  Notice and Disclaimer (2017): SEBI sent
30thOctober, 2016, press release issued , SEBI found notices to a dozen angel networks asking them
that:- to reveal details of their fundraising business.
“The electronic platforms are allegedly facilitating
investment in the form of private placement with
companies, as the offer is open to all the investors Disclaimer – “crowdfunding platforms are
registered with the platform amounting to a neither stock exchanges nor authorized by the
contravention of the provisions of Securities Contract capital markets regulator to solicit investments
(Regulation) Act, 1956 (SCRA) and the Companies and declare the securities traded on these
Act, 2013.”  platforms are not traded on any regulated
Questions raised on legality of platforms like, Lets exchange.”
Venture, Term Sheet, Equity Crest, Grex, etc.
Listed over six digital equity crowdfunding platform
“unauthorized, unregulated and illegal”
 JURISDICTION – SEBI OR MCA?

 SEBI doesn’t have absolute jurisdiction and overlaps with MCA as it is a hybrid of
both public offer and private placement.
 Crowdfunding participation not limited to listed public companies .
 Private placement not prohibited under companies act, 2013 and recognizes
maintenance of statutory register in electronic forms.
 MCA Jurisdiction –Residuary power for matters provided under the act, u/s 24 of
Companies Act, 2013.
 SEBI Jurisdiction (Sahara Case )- Section 55 A of Companies Act, 2013.
 COMPARATIVE ANALYSIS OF EQUITY
BASED FUNDING
PARAMETERS USA INDIA

 No restriction on who can invest  Only accredited investors permitted to

participate under a crowdfunding issue
under a Crowdfunding issue.
1. Eligible Investors

 Number of investors restricted to 200

persons (excluding QIBs)
 No limit prescribed on number of
2. Maximum Number of Investors
Investors  • QIBs: at least 5 times the minimum offer
value per person, subject to a minimum
collective investment of 5% of the
securities issued. • Companies: at least 4
3. Minimum Investment Limit times the minimum offer value per person
 No limits prescribed for minimum • HNIs: at least 3 times the minimum offer
investment under a crowdfunding value per person. • ERIs: at least the
issue minimum offer value per person.
 COMPARATIVE ANALYSIS EQUITY
BASED FUNDING
PARAMETERS USA INDIA
 Investment by individual investor in all  Investment by ERIs: • Individual
crowdfunding offerings in a 12-month investment limited to Rs. 60 000/-
4. Maximum Investment Limit
period not to exceed: • If either the annual (i.e. Euro 850/-) per ERI • Aggregate
income or net worth of the investor < $100 investment per ERI limited to 10%
000: the greater of $2000 or 5% of the of ERI’s net worth in one year
investor’s annual income or net worth,
whichever is lower • If both the annual
income and net worth of the investor are ≥
$100 000: 10% of investors’ annual
income or net worth, whichever is lower.

5. Requirements for Issuer  • Negative List as prescribed above where  • Positive List as prescribed above
Entity certain entities are not permitted to be where certain entities are permitted
issuer entities • Private Company to be issuer entities • Private
permitted to be an issuer entity Company not permitted to be an
issuer entity
 COMPARATIVE ANALYSIS EQUITY
BASED FUNDING
PARAMETERS USA INDIA
 • Certain activities (e.g investment  Such activities prohibited for
advice and solicitation and management crowdfunding platforms
6. Requirements for of funds/ securities) allowed to be
crowdfunding/ undertaken by a crowdfunding platform
intermediary platform if it is registered as a broker dealer (and
not permitted for a funding portal)

7. Restriction on
 • Transfer permissible in the secondary
transferability of market subject to a lock-in period of 1  • Transfer not permissible on
securities year or compliance with an exemption secondary markets • Exit
from the lock-in period • Exit available available to investor only upon
to investor not contingent on occurrence of certain events • No
occurrence of any event lock-in period prescribed for exit
 COMPARATIVE ANALYSIS WITH
OTHER COUNTRIES
Italy
One of the first nations to enact a law on Equity Crowdfunding was Italy. Regulation on "the collection of risk capital via on-line
portals (adopted by CONSOB) is the relevant law governing Crowdfunding. The thrust of the law is to regulate the process of
inflow of capital to "innovative start-ups" and "innovative SMEs".
Australia
In Australia, The Corporations Amendment (Crowd-sourced Funding) Act, 2017, amends the Corporations Act 2001 (Corporations
Act), and makes minor amendments to the Australian Securities and Investments Commission Act 2001 to govern provisions
relating to crowdfunding in Australia. The Crowd-sourced Funding (CSF) Regime seeks to reduce the regulatory requirements for
public fundraising while maintaining appropriate investor protection measures. It has been made obligatory for a CSF service
provider to hold an Australian Financial Services (AFS) licence.
New Zealand
Crowdfunding is a type of financial market service covered by the Financial Markets Conduct Act, 2013 (FMC Act). The FMC Act
regulates equity based crowdfunding. Companies are allowed under the FMC Act to raise up to $2 million in any 12-month period,
without having to issue an investment statement or prospectus (or a product disclosure statement from 1 December 2014). There
are relaxations in filing and other compliances for companies seeking to raise funds through a licensed crowdfunding service
provider.
 PEER TO PEER LENDING

 DEFINTION
More commonly referred to as “loan-based crowdfunding”, Peer-
to-Peer lending is:
1. Interaction between two parties without the need for an
intermediary who virtually meet and interact on a common
network;
2. For loans/ financial assistance of unsecured nature.
3. P2P from a financial perspective, is facilitation of lending
money to unrelated individuals, or "peers” without going through
banks or other traditional financial institutions;
4. Lending takes place online on peer-to-peer lending platforms;
5. Operationally less cumbersome;
6. Easy registration and less cumbersome evaluation and
documentation process along with faster loan processing time.
 RBI REGULATIONS FOR P2P LENDING

a) P2P NBFC Registration: P2P lending platforms are recognised by the banking regulator and they are
RBI released a required to register themselves under the Non- Banking regulation department, Mumbai. This move by RBI
gazetted notification will provide credibility to these online P2P lending platforms and will help in eliminating frauds.
on 18th September b) Net-Owned Fund: According to RBI, if a company needs to be called an NBFC, it must have at least 2
2017, According to crores or more of Net Owned funds so that company has a good financial standing in the market and is
which companies or backed up by some finance for uncertainties.
platforms that act as c) Escrow Account: They are required to create two escrow accounts separately. One account is for the
a loan facilitator lenders to record their disbursement of funds and other is for the borrowers to record their money
between lenders and repayments. This will make p2p lending a smooth process and will increase transparency in its transactions.
borrowers will be d) Limit for borrowers and lenders: borrowers can only borrow a sum total of Rs. 10 lakhs at any point
treated as NBFCs of time from the lending platforms but can only borrow an amount of Rs. 50,000 from a single lender at a
i.e. Non-banking single point of time. Similarly, investors can invest a sum total of Rs. 10 lakhs in all the lending platforms
but can only lend an amount of Rs.50,000 to a single borrower.
financial companies.
Rules: e) Submission of data: All the P2P lending platforms are required to submit every detail o the p2p lending
transactions in and out to RBI. RBI will watch all of their activities closely in order to prevent fraudulent
transactions.
 The following table summarises the dos and
don’ts under the RBI guidelines for NBFC-P2P:

Dos: Don’ts:
 Act only as an intermediary;  Not raise deposits;
 Ensure adherence to legal requirements applicable to the  Not lend on its own;
participants;
 Not provide or arrange any credit enhancement or
 Store and process all data relating to its activities and
participants; credit guarantee;
 Undertake due diligence of participants;
 Not facilitate secured loans;
 Undertake credit assessment and risk profiling of the  Not hold on its own balance sheet any funds
borrowers and disclose the same to their prospective received from lenders and borrowers;
lenders;  Not cross-sell any products on its platform except
 Undertake documentation of loan agreements and other for loan specific insurance products;
related documents;
 International flow of funds is prohibited
 Render services for recovery of loans originated on its
platform.  Not release credit information
 COMPARATIVE ANALYSIS PEER TO
PEER LENDING
PARAMETERS UK INDIA

 Platforms required to abide by certain  Client monies required to pass

1. Client Money Rules Client Money Rules regarding client directly from the lender’s
funds, including deposit of client account to the borrower’s
money with a third party. account: No role for platform in
the collection of monies

2. Prudential Norms  The higher of £50,000/- or a

percentage of a volume-based financial  Minimum capital of INR 20
resources requirement calibration million (i.e. Euro 0.28 million
approx.).
 COMPARATIVE ANALYSIS PEER TO
PEER LENDING
PARAMETERS UK INDIA

 Not applicable  Proposed to be specified

3. Leverage ratio

4. Protection of small investors

 No specific guidelines proposed
 Specific guidelines prescribed

5. Provision of Cancellation
Rights  Cancellation of investments by  No such provision contemplated
investors permitted under certain
conditions
 COMPARATIVE ANALYSIS WITH
OTHER COUNTRIES

US
P2Ps are regulated by SEC. While SEC would monitor the lending-investing
procedure, agencies like Consumer Financial Protection Bureau (CFPB) and
Federal Trade Commission (FTC) would monitor the borrower side of
operations. The states are allowed to apply different laws as per their
suitability. Certain states like Texas have completely banned P2P business
while some have placed restrictions on their financial capacity. SEC had
cumbersome regulations in place which included listing of companies, shelf-
registration of loans and uploading disclosures as per SEC’s EDGAR
(Electronic Data Gathering, Analysis and Retrieval system); it led to
LendingClub to close operations for a year. The regulations by SEC made
the loan disbursal process costlier and sophisticated.
IMPACT OF COVID-19

 Equity Crowdfunding  P2P Lending

The lack of equity crowdfunding projects to report Traditionally, P2P lending platforms have been charged
with attracting borrowers that are unable to access credit
on demonstrates the longer time scale involved to
from banks and other FIs. While this may be partly true, it
spot a market need, found a business, assemble a by no means undermines the quality of borrowers attracted
senior management team, formulate a business plan, to the low-cost loan offerings from P2P lending platforms.
and create a viable equity crowdfunding project as a However, lockdown across nations has meant restricted
means to finance a startup business. movements and little to no access to banking infrastructure.
While most traditional FIs boast of an online loan
Overall, the coronavirus pandemic has hit investor application system, not many have made the effort to
confidence. In the UK, equity crowdfunding develop systems that enable online verification and
generated £500m worth of capital funding into processing of such loan requests. As a result, while
companies last year.  Since the coronavirus outbreak borrowers may be able to apply for loans online, not many
started, that rate of investment has fallen by 75%. traditional FIs are able to disburse. Here online lending
platforms have an edge invested considerable amount of
time
SUGGESTIONS AND CONCLUSION