Increasingly, entrepreneurs rely on the internet for fundraising as a result of the internet being an integral part of our lives. Before embarking on such a journey, Indian entrepreneurs and business owners should consider several things. The Internet is an excellent tool for fundraising. Here is everything you need to know.
Crowdfunding: What is it?
Using websites and social media platforms, crowdfunding is a way for fledgling businesses to raise funds from multiple investors for a specific purpose. Projects such as the release of a book, music video, or new product can be funded with the funds collected. Such funds may also be used to support charitable and benevolent causes, such as building a business or community initiatives. Those methods offer a modern alternative to more traditional forms of funding, such as contacting a bank or other financial institution. By making small contributions, they fulfill your business’s fund needs with the power of cumulative effort.
Crowdfunding Types in India
- Community-based crowdfunding techniques such as social lending provide a legal way for individuals to contribute without any expectation of return. Typically, these donations are from artists or social causes seeking financial support for their projects.
- Pre-order crowdfunding: Investors contribute money to receive an item or service at a later time through pre-order crowdfunding. For example, individuals pay today for a product they know the company will make and deliver after a designated period.
- Crowdfunding with a reward: This is a type of legal community-based crowdfunding where people donate money in the hope that they will receive a reward later on.
- Crowdfunding for debt is a form of peer-to-peer lending that matches prospective investors with issuers using an internet platform. The platform offers unsecured loans to these borrowers at an interest rate determined by the platform. In India, only NBFCs with licenses may conduct such transactions.
- Equity-based crowdfunding is an early stage funding method in which businesses offer equity interests to investors online.
Are All Types of Online Fundraising Legal in India?
In India, equity-based crowdfunding is considered illegal by SEBI, the Securities and Exchange Board of India. The SEBI is responsible for regulating the securities market in India, and its Protecting the interests of investors within the country is the primary objective. It is a type of unregulated investment, so equity-based fundraising comes with several risks. Lack of relevant skills and experience may result in heavy losses if the investors lack the ability to assess risk.
Investors with limited savings may invest in such risky activities in the hopes of a higher return. Other investors’ liquidity is, however, hampered by the absence of regulations and security from issuers. The investor is also unable to access hard information in these cases. Unlike venture capitalists and other financial institutions, they cannot undertake the required due diligence.
India’s startups are primarily funded by angel investors, loans from financial institutions, and private equity. It is not until a business is commercially viable that a public offering of equity takes place. The majority of equity crowdfunding funding comes in the early stages, typically during pilot development. Since crowdfunding does not have any rules, investors are not protected by these methods. As of yet, India has not formulated guidelines that will help minimize investment risks and increase market liquidity in such cases.
A Guide to Online Fundraising from SEBI
A document titled ‘Consultation Paper on Crowdfunding in India’ published by SEBI in 2014 provided guidelines on online fundraising in India. These guidelines include:
- Only accredited investors should be allowed to participate
- At least 5% of the issued securities must be held by qualified institutional buyers
- Retail investor contributions must be between *20,000 and *60,000, and the maximum number of retail investors is 200
- Fundraising drives for startups less than two years old are allowed
- Financial information, management information, and business plans must be disclosed by all participating businesses
- Platforms that have been registered with the SEC are required to set up screening committees to conduct due diligence on startups and investors.