Equity crowdfunding in India: Risks and benefits
By: Jasmine Marfatia
Published On: August 06, 2018
We give you the lowdown on equity crowdfunding in India - the risks, the benefits, and the laws.
The beauty of crowdfunding is that there are different types to suit the purpose of a crowdfunder. There are four type of crowdfunding methods today, only two of which are accepted in the Indian economy - donations based, rewards based, equity crowdfunding, and debt-based crowdfunding. Before we delve into the details of equity crowdfunding in India, we must get an understanding of all types of crowdfunding options available.
Donations based crowdfunding
Donations based crowdfunding which has already boomed in India, follows a philanthropic approach where in people simply contribute money for a cause (medical, charitable, educational), a business, a project, or any other initiative, without expecting anything in return for they funds they donate. In India, most campaigns are donations based ones, mostly used by people who need assistance in raising funds for expensive medical procedures.
Rewards based crowdfunding
Rewards based crowdfunding promises the contributor a small or large reward in exchange for the financial contributions, depending on the amount contributed. Offering rewards is a useful marketing strategy that helps incentivize two sets of people: 1) Your loyal supporters, who will have reason to stay with your cause and provide long term support.
- 2) It will help convert potential donors into sure-shot donors, who can expect a reward in return for their funds. Rewards are mostly in the form of tax exemptions, free sample, brand merchandize, early access to a product or service, invites to an event, tickets to events, meet-and-greets, shout outs on social media, personalized gifts and thank you notes.3. Debt based crowdfunding
Debt crowdfunding is a fundraising approach where a contributor or an individual will lend money to a business or social enterprise, and effectively become a lender to that company. This means the lender would expect to be repaid for their contribution with added and fixed income and return on capital. Debt based crowdfunding or peer-to-peer lending is an effective solution for small businesses, start-ups, and social enterprises to not only gain financial support, but also gain access to other business resources. This form of fundraising is not usually practiced in India.
Equity based crowdfunding
Finally, we have equity crowdfunding, which, as per the crowdfunding regulations in India, is illegal. This is a form of crowdfunding where the contributors would technically become stakeholders of a firm. In equity crowdfunding, the contributors receive a share of the profits earned by the company, but they would also incur losses. Equity based crowdfunding is a high- risk method of fundraising, and therefore needs to be regulated by a regulatory body.The risk involved in equity crowdfunding
Very often people confuse debt and equity- based crowdfunding, but the key difference is the return to the contributor. In debt- based crowdfunding, the lender get a fixed income, and in equity- based crowdfunding the investor gets a share of the profits made.
Equity crowdfunding is more risky than debt crowdfunding. As people are still exploring and accepting the potential of online fundraising, donations and rewards based campaigns are the only ones that are legal and unregulated in India. Crowdfunding campaigns that solicit funds in exchange for equity, income or a share in the company are disallowed by law.
Emergence of equity crowdfunding in IndiaTo backtrack a little, we need to understand the emergence of angel investors. Earlier, a business that needed capital would go to a bank and ask for a loan. But the procedures involved in getting loans were long drawn and difficult, and you always ran the risk of getting denied. Eventually, people sought out angel investors or venture capitalists who provide funding in exchange for part ownership of the company.
As we entered the technological revolution, the digital economy brought with it online crowdfunding, leveraging the power of the internet to raise capital. As a result, more people would have the chance to become investors and invest in securities. The SEBI then deemed it illegal, after examining its high risk nature, and the potential disadvantages it posed to investors. In addition, the worry of online platforms being misused for money laundering and fraud led to the present legality of equity crowdfunding in India, as well as some other countries.
The legality of equity crowdfunding in India
With regards to equity crowdfunding in India, SEBI (securities exchange board of India) is the regulatory body that determined the legal status of it. Further, we shall explore the prospects of equity campaigns, and how legalizing it can impact the burgeoning start-up culture in India.
SEBIs concerns regarding fraud, money laundering, and potential failure are legitimate. However, exacting some control by designing legal framework that will determine eligibility of investors and businesses both, may allow some control to minimize risk. On the startup front this could mean a stringent due diligence process, disclosure of risk, monitoring the amount raised, and rules and regulations for reporting. For investors it could imply a minimum net worth, and a cap on investments upto a certain percentage of their net worth. In addition, equity crowdfunding India platforms must ensure cyber security and safe fund transfers.
A way around the legal status of equity crowdfunding: Recognizing the benefits
As a result of the illegal status of equity crowdfunding, businesses and start-ups in India found ways to avail some of the other benefits that online fundraising has to offer. Crowdfunding isn’t just a space to raise money, but rather platform that unifies startups/ business owners with interested and potential investors. Moreover, it facilitated the sharing of ideas that allowed entrepreneurs to test the market demand for their product/ service. It was essentially a platform to make a pitch to the masses. Investors that were interested in an idea would simply carry out the investment process offline, making it a completely legal process.
The question we are now left with is whether the economy will be able to progress in sync with the digital era. The fact remains that equity crowdfunding campaigns can change the landscape of entrepreneurship and promote and environment that encourages new ideas and new business by making capital easily accessible.
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