Jurisdiction - India
Reports and Analysis
India – SEBI Proposes Crowdfunding Norms.

31 July, 2014

 

 

Securities market regulator in India, Securities and Exchange Board of India (“SEBI”) floated a concept paper on Crowdfunding in India in June, 2014, discussing inter alia, the concept, purpose, legal and regulatory aspects and implementation issues in crowdfunding. The paper discusses the proposal to introduce the framework for aiding access to crowd funding as an additional avenue for funding of start-ups and SMEs by providing access to the capital market and regulation thereof. As opposed to the historical methods of start-ups funding through private equity, angel investments and loans which are generally available after the business is somewhat settled in terms of commercial viability, crowdfunding aims at raising funds at a nascent stage of a business. Currently,the area of crowdfunding is not monitored or regulated through any particular law, for which SEBI through this concept paper has taken a step to forward in view of not only providing for new options for raising funds by newly set up business but also to regulate and monitor the source, flow and operation of funds so raised.


The Concept


Crowdfunding refers to raising funds, generally small amounts, by solicitation from multiple investors. The funds are raised through web based platforms, social networking sites etc., for specific projects, social cause or business ventures. IOSCO (International Organisation of Securities Commissions) Staff Working Paper –Crowdfunding: An infant Industry Growing Fast, 2014, on which the concept paper appears to have relied quite a bit, categorises crowdfunding into four categories:

 

  • Donation crowdfunding: Raising funds for social, charitable, artistic o rsimilar purpose and does not involve any returns to the investors.
  • Reward crowdfunding: Investors receive some existing or future tangible reward in return.
  • Peer-to-peer lending: Involves matching of borrowers with the investors
  • Equity crowdfunding: Involves issuance of equity shares to the investors in consideration for funds solicited from them.

 

Existing Regulatory Framework


Currently, the mechanism of raising funds by the companies are governed under the Companies Act, 2013, SEBI Act, 1992, Securities Contracts (Regulation) Act, 1956 (“SCRA”)and the Depositories Act, 1996 and various related regulations. The Companies Act, 2013 provides that the issue and transfer of securities by listed companies or by the companies which intend to get its securities listed shall be governed by SEBI and accordingly the public issuance of securities and private placements proposed to be listed on the stock exchanges are regulated by SEBI. Public issues of specified securities are required to comply with the requirements of SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (“ICDR”), while issuance of debt securities require compliance with the SEBI (Issue and Listing of Debt Securities) Regulations, 2008 (“ILDS”). Recently, under the Companies Act, 2013 and relevant Rules thereunder, have put certain restrictions on private placements which was earlier feebly regulated, to prevent them is use of the liberal regulations.


Coming to facilitating the funding of the start-ups and SMEs, SEBI has taken various measures through devising certain routes of funding such as SME Segment of Exchanges, Institutional Trading Platform (ITP), Category-I SME Fund under AIF Regulations.


SMEs can list their securities in the SME Segment of the recognized stock exchanges and such SMEs have been provided various relaxations under the ICDR such as filing of offer document directly with the stock exchange and not necessarily with the SEBI, relaxation in the eligibility criteria and minimum number of prospective allottees etc. The relaxations are also provided for such SMEs with respect to continuous listing requirements for companies listed in SMEs.


SMEs including the start-up companies are permitted to be listed on the SME Exchange ITP without the requirement of making an initial public offer. The objective of the ITPs is to provide initial impetus to the SMEs rather than sustained listing over a long term horizon.
SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”) were notified by SEBI in May, 2012 with an objective to facilitate increase in investments in new start-ups, SMEs etc. and to provide fora mechanism to monitor and assess risks to the marketstability. The purpose of the AIFs Regulations was to regulate the unregulated funds with a view to increase systemic stability, market efficiency along with encouraging raising of new capital with apt consumer protection. The AIF Regulations include within its purview all the alternative investment funds including private equity funds, real estate funds,hedge funds etc.


The Proposal


Since Donation Based, Reward Based and Peer-to-Peer crowdfunding do not generally involve issuance of securities for a financial return, it would not be subject to regulation by the SEBI. The proposal seeks to explore the options of a regulated security based crowdfunding through a web-based platform, within the existing legal frame work in India, as discussed earlier. The options being consideredare:


(i) Equity based Crowdfunding (“EbC”);


(ii) Debt based Crowdfunding (“DbC”);and


(iii) Fund based crowdfunding(“FbC”)


While EbC and DbC are primarily based on the private placement route as provided under section 42 of the Companies Act, 2013, FbCis based on the AIF Regulations.


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.


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. 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.


For the FbC, the funds of the accredited investors will be collected online and pooled under the AIF to invest in shares or debt securities in crowdfunded ventures which are displayed on a recognized crowdfunding platform.


Eligible Investors:


The Proposal seeks to permit only the “Accredited Investors” to participate in the crowdfunding as of now. Accredited Investors would include the Qualified Institutional Buyers (QIBs) as defined in the ICDR, companies with a minimum net worth of INR 200m, High Net Worth Individuals (HNIs) with a minimum net worth INR 20m or more (excluding the value of the primary residence or any loan secured on such property), Eligible Retail Investors (ERIs), as specifically defined under the concept paper. The idea behind restricting the eligible investors for crowd funding is to have only those investors involved in the crowdfunding who have the requisite market knowledge and experience, access to the investment advice and have sufficient resources to bear any losses on their investments, considering the risks involved in the start-up business owing to the speculative nature of such businesses at an early stage.

 

Conditions, Limits And Disclosures:


It is proposed that EbC and DbC would allow private placement offers through net-based crowd funding platforms to any number of QIBs and a maximum of 200 HNIs and ERIs collectively, in view of the provisions of Companies (Prospectus and Allotment of Securities) Rules, 2014 which prohibits private placement offers to more than 200 investors in a financial year excluding the QIBs and employees of the concerned company. Holding of minimum of 5% of the securities issued by the QIBs collectively is proposed. A HNI would be required to purchase at least 3 times the minimum offer value per person and an ERI would be required to purchase at least the minimum offer value per person and the limit of investment of an ERI in an issue is proposed to be capped at INR 60k. Further, total crowd funding investment of an ERI in a year would be capped at 10% of its net worth.
The Accredited Investors intending to invest through crowdfunding mechanism would need to maintain a demat account, as the issue would be required to be in demat form. The payments would be required to be made through normal banking channels.


The issuers would be required to make adequate disclosures, though not as exhaustive and extensive as IPOs. It is proposed to that an intending issuer would be required to submit a Private Placement Offer letter to the crowdfunding platform with the requisite information about the issuer,which would be circulated to the selected registered accredited investors. Besides initial disclosures, the issuer would be required to make ongoing disclosures regarding the financial information and the state of business of the business.


Eligible Issuers:


The option of raising funds through EbC and DbC routes is proposed to be restricted to an early stage SME or start-up which is an unlisted public company incorporated in India which is not older than 48 months. Additional conditions include that the company should not be intending to raise a capital of more than INR 100m in a period of 12 months, it should not be promoted,sponsored or related to an industrial group which has turnover exceeding INR 250m or has an established business. Further, the said company should restrict its business to non-financing ventures and not be engaged in real estate activities and activities not permitted under India’s industrial policy. Furthermore, the company, its directors, officers, associates etc. should not have been prohibited from operating in capital market or have any adverse directions from SEBI regarding dealing in securities,should not have been categorized as a defaulter by RBI or CIBIL and its directors and promoters should not be disqualified under the provisions of the Companies Act, 2103. The investee company would not be allowed to use multiple crowdfunding platforms in a given period of 12 months, crowdfunding issues would be required to be routed only through SEBI recognized platform and the investees would be required provisions for over subscription which may include maximum over subscription amount to be retained and should not exceed 25% of the actual issue size.


The Crowdfunding Platform:


It is proposed that the online platform to be used for crowdfunding should be a SEBI recognized platform. Three (3) classes of crowdfunding platforms are proposed: (i) Class I – Recognised stock exchanges (RSEs) and SEBI registered Depositories;(ii) Class II- Technology Based Incubators promoted by the Central Government or any State Government fulfilling certain conditions as specified under the paper. A joint venture of Class I and Class II entities would also be eligible to set up a crowdfunding platform; and (iii) Class III – Associations and networks of PE or Angel Investors which specify certain conditions.


It has also been proposed to enable FbC, that the new class of Crowd Fund AIFs be displayed on the platforms launched by RSEs and depositories.


The crowdfunding platforms would be obliged to conduct screening and basic due diligence of the issuers and investors and a specific “screening committee”has been proposed to be setup.


Conclusion


Crowdfunding comes forth as a welcome step to enable the small enterprises and new businesses to raise funds. With the increasing levels of computer literacy and internet access, it is likely to prove as a convenient mode of not only raising funds for the ones who wish to start up or expand their new business due to relaxation in terms of complex requirements such as issuance of prospectus, listing requirements etc., but also a good option for those who would be interested in making small investments in the business with new ideas. While expecting that the regulations would be in place soon, it can be hoped that the mechanism would provide impetus to the economy of the country. The economy is expected to be benefitted from the idea of raising capital at a lower cost, and increasing healthy competition. However, at the same time the issues and challenges as regards implementation of the idea cannot be ignored owing to the high risk, low liquidity, systemic risks, cyber security issues etc. Therefore, the need would be to balance the facilitation of fund raising with the protection of the investor rights from the risks.

 

RSP-Logo

 

For further information, please contact:

 

Ravi Singhania, Partner, Rajani Singhania & Partners

ravi.singhania@rsplaw.in

 

Rajanji Singhania & Partners Capital Markets Practice Profile in India

 

Comments are closed.