Jurisdiction - India
Reports and Analysis
India – Risks Of Crowdfunding.

6 October, 2014

 
 

EbC would enable the issuers to raise funds online, up to INR 100m by issuing equity shares to the accredited investors. A single investor would not be allowed to hold more than 25% stake in a company and the promoters shall be required to maintain an equity stake of minimum 5% for at least 3 years. The investors would have the rights of an equity shareholder as provided under the Companies Act, 1956 [Companies Act, 2013]. Similarly, DbC would enable the issuers to raise funds online, up to INR 100m by issuing debentures or debt securities to the accredited investors. The debt securities should comply with the requirements of the Companies Act, 2014 [Companies Act, 2013]. A debenture trustee would be required to be appointed by the investor and a Debenture Redemption Reserve of 25% of the value of the debentures would be required to be created. The investors would have the rights of debenture holders as provided under the Companies Act, 1956 [Companies Act, 2013].


Substitution Of Institutional Risk By Retail Risk:

 

  • Entities solicit investments in smaller sums from large number of investors. Hence, the risk taking by VCF/PE (informed investors) is substituted with retail investors, whose risk tolerance level may be very low.

Risk Of Default:

 

  • There is no or less recourse to the investors against the issuer, in case of default or fraud;
  • There is no collateral (even in case of peer to peer lending), as in case of Corporate Bonds;
  • Public funding is sought on the basis of future possibilities as against the clear evidence of a viable existing business model, which is needed under the existing regulations. Investments in companies without viable business model increase the risk of failure and loss to equity investors;
  • The risk of failure is further increased by the fact that the funding is potentially by participants who do not have the skills and experience needed to assess the risk before investing/lending.

Risk Of Fraud:

 

  • There is a risk of misuse as well as cyber-security and/or identity theft.

Central Role Of The Internet:

 

  • The central role of the Internet and its wide reach would increase the number of persons potentially affected, which can be significantly greater than the traditional means of fundraising;
  • Funds could be raised from investors residing at various countries without complying with requirement of local laws of various jurisdictions.

Systemic Risk:

 

  • Investors may not practice good diversification principles;
  • Risk of illiquidity;
  • Possibility of Money laundering;
  • Risks could become systemic;
  • Cross-border implications.

Information Asymmetry:

 

  • High chances of information asymmetry;
  • No monitoring of these platforms;
  • Lack of transparency and reporting obligations;
  • Possibility of omission of information and misinformation providing;
  • Distorted view of the issuer or the actual investment.

Substitution Of Existing Regulatory Framework:

 

  • Peer to Peer Lending acts as a Bank by matching lenders/investors with borrowers/issuers, without complying with any of the rigid requirements of Banks;
  • The Disclosure and due diligence involved in Crowdfunding platform cannot be compared with existing framework;
  • Further, even private placement requirements have been tightened in India recently.

 

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For further information, please contact:

 

Prachi Doshi, Rajani Singhania & Partners
prachi.doshi@rsplaw.in

 

Rajanji Singhania & Partners Capital Markets Practice Profile in India

 

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