Equity-Based Crowdfunding as an Early-Stage Financing Alternative: Critique of the Regulatory Proposals in India

With over 4200 start-ups, India is the fastest growing start-up ecosystem worldwide. It has the third-largest number of start-ups in the technology sector following the US and the UK. However, India is experiencing an exodus of start-ups to jurisdictions with more favourable regulatory regimes. Singapore, for instance, offers many benefits for start-ups including less stringent compliance requirements, tax credits for investors, zero capital gains tax and grants for research and development. In contrast, Indian start-ups suffer from high taxation on angel investments, weak patent laws and excessive bureaucracy in both incorporation and fundraising stages.

Recognizing start-ups’ potential in boosting the economy, the securities market regulator, Securities and Exchange Board of India (“SEBI”) has introduced reforms aimed at improving access to funds for start-ups and small-to-medium enterprises (“SMEs”). SEBI amended the SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”) to regulate ‘angel funds’. Relaxations in SME listing norms were introduced under Chapter XB of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (“ICDR Regulations”) to allow for stock exchanges to have a separate SME trading platform. Keeping up with this positive trend, in 2014, SEBI released a ‘Consultation Paper on Crowdfunding in India’ inviting suggestions from all stakeholders on regulatory proposals.

This post aims to analyse equity-based crowdfunding as an early-stage financing alternative in India in light of SEBI’s proposals. The first part introduces crowdfunding and examines its benefits and risks, underlining the need for a regulatory framework. It then discusses financing avenues available to start-ups to study if existing regulatory provisions can be used to regulate crowdfunding. Finally, it critically analyzes SEBI’s Consultation Paper to understand if economic objectives of crowdfunding are fulfilled and provides recommendations on the way forward.

Equity-Based Crowdfunding: Benefits And Risks

Equity-based crowdfunding involves solicitation of funds by start-ups from investors through an intermediary online platform in return for issuance of securities such as equity shares.

Crowdfunding has recently gained traction as a viable fundraising alternative, with jurisdictions around the world introducing laws to regulate it. The recent global economic meltdown has made access to secured loans difficult for start-ups that have little or no collateral to offer. Private equity (“PE”), venture capital (“VC”) investments and public offerings are inaccessible to many start-ups which are usually sensitive to a higher cost of capital and are not far enough in their life cycle for conventional financial intermediaries to adequately assess risk and commit to an investment.

Read Full Article