In the wake of financing shortages resulting from the global financial crisis in 2008, crowdfunding emerged as an alternative capital raising mechanism, particularly for start-up companies. As an attractive alternative capital-raising mechanism for start-ups, equity crowdfunding harnesses technology (primarily the Internet) to access funding from a large number of investors, ie the ‘crowd’. Since then, while crowdfunding has grown exponentially, it has also encountered regulatory constraints in the form of securities laws in various countries that could stand in the way of unleashing its full potential.
Equity crowdfunding is advantageous to start-ups as it enables them to cast a wide net in raising funds and, given the power of the Internet, to reach investors anywhere in the world. At the same time, crowdfunding activity attracts significant risks to the crowd. As most start-ups engaged in crowdfunding are new businesses whose profitability is unknown, the chances of failure are magnified. Moreover, the rather anonymous nature of online activity accentuates the risk of fraud, principally due to information asymmetry between businesses and investors. This leads us to the core question: how should one regulate equity crowdfunding in a manner that enhances its appeal, in order to facilitate the development of small and new businesses through accessible funding opportunities, and, at the same time, protect the investors against undue risks, such as fraud, which arise from the activity? Given the novelty of crowdfunding, regulators in several countries are grappling with these tensions with a view to designing an appropriate regulatory regime.
In our paper, ‘Regulating Equity Crowdfunding in India: Walking a Tightrope’, we explore these core questions and the regulatory conundrum by examining the legal regime for crowdfunding in India. The country presents itself as an ideal laboratory for crowdfunding. It has a burgeoning but vibrant start-up culture that has spawned the growth of innovation and start-ups, which have constant funding needs. On the supply side, the enormity of India’s crowd presents unparalleled crowdfunding opportunities: a population of over 1.3 billion people with approximately 24.5 million households that actively invest in securities markets. Despite the existence of a combination of factors that ought to facilitate equity crowdfunding, however, the idea is yet to take off in India. This can be attributed to the existence of stringent regulation that prohibits businesses from raising finances from the crowd without complying with norms relating to public offerings of securities.
As we discuss in our paper, the rules in India relating to fundraising by companies have been considerably tightened under the Companies Act, 2013. Unless fundraising offers are made to a very limited number of participants, they will be treated as public offers that require businesses to follow a plethora of disclosures and compliance obligations. Such a strict regime was the result of several scandals that involved corporate groups raising millions of dollars in investments from tens of thousands of investors in the garb of private placements without complying with the necessary regulatory requirements. However, the Securities and Exchange Board of India (‘SEBI’), India’s securities regulator, has expressed some interest in creating a market for crowdfunding in India by issuing a consultation paper in 2014 which proposes a framework for ushering in equity crowdfunding in India by providing capital market access to small businesses. However, as we argue, SEBI’s proposals contain significant limitations and onerous conditions which might have the effect of stifling, rather than promoting, the growth of crowdfunding in India.
In analysing equity crowdfunding regulation in India, we find that the regulators have engaged in a tightrope-walking exercise by signalling their interest in promoting a market for crowdfunding to enable small businesses, but, at the same time, introducing significant measures towards the protection of the crowd. In our view, the unduly onerous conditions imposed by SEBI, including limiting crowdfunding to accredited investors and retail investors who must meet high thresholds of eligibility, will have the effect of ‘taking the crowd out of crowdfunding’, thereby rendering it hollow and will not provide the intended benefits to small businesses. On the other hand, due to the prevailing circumstances in India regarding mass fundraising efforts, as a result of largescale frauds, we do not believe that the Indian markets are equipped to handle a more liberal regime towards fundraising. Either way, we are not sanguine that regulatory efforts will promote or facilitate equity crowdfunding in the Indian markets. Hence, start-ups may have to confine themselves to venture capital, angel investment and other traditional forms of financing.
Arjya Majumdar is Assistant Professor and Assistant Dean (Academic Affairs) at the Jindal Global Law School, and Umakanth Varottil is Associate Professor at the Faculty of Law of the National University of Singapore.