Is crowdfunding Legal in India?
Crowdfunding refers to the utilization of funds from multiple investors for a predetermined aim through social-networking sites or web-based platforms. Such objectives or aims could be for a project or idea, (for instance, book publication, music or film) a public cause (for instance, community-based initiatives or causes) or for setting up a venture. Small financial contributions from the backers or supporters can fulfill the fund requirement of the ventures, which faces a shortage to access such funds.
Origin Of Crowdfunding
India, which is progressing as the world’s fastest booming startup ecosystem and economy has entered the world of online crowdfunding. Crowdfunding is not a new practice. It has been practiced for a long time and has its origins from the West. Crowdfunding is not just assisted to fuel up the startups but also aids in providing solutions to issues in social and medical fundraising. The rules and regulations of crowdfunding differ from one country to another.
Legality of Crowdfunding In India
This is one of the generic questions which we hear, Is Crowdfunding Legal in India? And the answer is yes, it is legal in India except for equity-based crowdfunding. Other types of crowdfunding are substantially legal in India. Below are the different crowdfunding and their legal implications to operate in India.
1 Reward-Based Crowdfunding
As the name suggests, this type of crowdfunding rewards the backers with non-financial benefits or rewards in return for the pool of contribution made by them towards the venture. The startups reward the supporters as a way of appreciating them for taking part in the capital pool required for their ventures. This type of crowdfunding is applicable for creative ideas, project or products/services. The rewards could be in any form like tickets for an event, gifts, coupons, etc.
As reward-based, crowdfunding does not entitle in giving monetary benefits towards the capital contribution made by the backers and hence does not fall under SEBI regulations. It is legal to practice in India and is operated by many crowdfunding platforms.
Reward crowdfunding can cause some issues if the rewards agreed upon don’t deliver on time or varies from what was promised. Because of the absence of specific rules and regulations, the backers are left with no option for grievance redressal. Crowdfunding platforms come up with stringent policies that justify the authenticity of the campaigners and the delivery of rewards. In the case of the campaigner’s failure, the platforms are not liable to take any action.
2 Debt -Based crowdfunding
In this type of crowdfunding, the company owes a certain amount as interest to the investors or supporters who have invested in the venture. The investors have the advantage of earning interest on their investment at a certain period which is subjected to market variation. The startup can get the maximum number of support through this category, as there is availability of fair returns on investment by which the backers are attracted.
This type of crowdfunding takes place online and is legal to operate in India. However, the rules and policies to abide by the venture in this type of crowdfunding is regulated by RBI (Reserve Bank of India) under the purview of SEBI. Which is still under the process of drafting the right regulations that would govern the process of the lending market and has categorized all the P2P platforms under NBFC (Non-Financial Banking Companies).
Debt-Based crowdfunding or P2P lending is exposed to market fluctuations and comes with substantial risks in terms of fraud. Hence, it is essential for the venture to be deliberate and do a thorough analysis before lending on any platform.
3 Donation-Based Crowdfunding
In this type of crowdfunding, the supporters or backers are not rewarded, nor are they paid interest on their investment made for the ventures. Over here the contributions made by the supporters are termed as donations without any motive of return. People contribute to this type of crowdfunding, since they come up for a specific cause, and the backers believe in the cause and invest it. The campaigns launched here are completely caused-based. For example, funding the transport for food and clothing in an affected area, or any relief charities which are seeking funds for rescue and recovery.
Donation crowdfunding is a community crowdfunding and is legal to operate in India. Just like reward-based crowdfunding, donation-based crowdfunding is also popular and is common in many crowdfunding platforms. This type of crowdfunding can back or support any project or cause, and also the contributors have an added advantage in terms of tax benefit. The contributors are entitled to receive tax deductions for their contributions depending on the cause or project.
4 Equity-Based crowdfunding
Equity crowdfunding is a type of crowdfunding, wherein the startups have to sell off a part of their stake or share to the outsiders in return of capital. It helps in the early access of funds to the companies which are still in the embryonic stage. It is a popular method of funding utilized by small businesses or sole proprietors. Inequity crowdfunding, the shares are sold at a much earlier stage.
Regulating body SEBI has prohibited the practice Equity crowdfunding and is illegal to operate it in India due to the involvement of high risk. For instance, if the venture turns out to be profitable or successful, substantially the share value rises and if not the value is lowered. This type of fundraising involves gamble, and hence risky to bring into practice. It is also termed risky as the investors might lack the necessary skills to analyze or the risk before investing in it.
Future of Crowdfunding
Crowdfunding is still in its early stage in India but is focused to grow fast irrespective of a few irregularities and policies of its operation. SEBI and RBI have been trying to draft a fair framework of policy and regulations over the impact of crowdfunding and its legal implications in India. But because of the market size being limited, it leaves many opportunities unexplored and undiscovered. It is a task to draft an ideal law or policy. However, the regulating body SEBI has noticed the need to formulate the business model. And has released a paper acknowledging the same.
Here are a few guidelines by SEBI for crowdfunding, which includes:
- Only Accredited investors are allowed to invest;
- Contribution of retail investors is minimum -INR 20,000 and maximum- INR 60,000;
- Maximum number of retail investors is 200;
- Only startups who are aged less than 2 years are eligible to participate;
- Startups have to disclose their business plans, the utilization of funds and financial statements.
Startups funding in India is been revolutionized and has great success stories which are organized by platforms like NASSCOM, catapoolt, and Payumoney. Crowdfunding in India is at a growing pace and with the availability of the right rules and policy in place, it would be the next big thing in the startup sector.