A step forward, 2 backwards: How Sebi could kill crowdfunding before it takes off

After amending stipulations for angel funds last year, stock market regulator Securities and Exchange Board of India (Sebi) made yet another landmark move last week when it released a consultation paper to regulate crowd funding in India in order to rake up a new stream of raising early-stage capital by young companies.

Though a step forward, Sebi’s pilot norms have faced a fair amount of flak from the start-up ecosystem who view it as over-cautious and rigid, thereby effectively killing the concept in its infancy.

The fine print

“These guidelines are basically to test the model, identify glitches and keep a check on fraudulent activities,” says Sneha Kohli, Co-Founder, National Crowd Funding Association (NCFA), an organization promoting crowd funding in India.

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The details as of now, that have been spelt out for equity-based models only, appear sketchy with a few loopholes, say people in the start-ups industry.

For beginners, the paper proposes that only defined and limited entities should be allowed to launch crowd-funding portals. These include existing exchanges, registered depositories, technology incubators in existence for over five years and angel investor groups.

Satish Kataria, managing director, Catapooolt, a crowd funding platform for creative projects, terms this as “backward”.

“The current entities already have their attention on other financial models and investment management. None of them have a deep understanding or even inclination to launch crowd funding. Depending on them to bring this ‘financial innovation’ may put the model back by a few more months as they will take time to understand crowd funding dynamics,” he says.

There are four broad models in crowd funding prevalent today: rewards, donation, investment and lending. Catapooolt comes under the rewards model.

Describing it as ‘restrictive’, Kataria adds that these guidelines ignore other non-start-up project categories, like films or creative projects, that may benefit from equity crowd funding.

Further, it does not accept the fact that there may not be valid secondary markets for crowd funded securities which can aid growth of a nascent concept in India.

A small pool

According to Sebi, companies will be allowed to raise Rs 10 crore in a year through crowd funding platforms but individual investors are limited in an issue to 200. While limiting optimal raise is seen as a prudent move and an appropriate number too, stakeholders feel Sebi needs to increase the investor pool, especially as the market matures.

The rules, if implemented, will also make it mandatory for institutional investors to buy at least five percent of a crowd funded issue, while limiting maximum investment by an individual to Rs 60,000 per issue. Both clauses together make norms highly restraining and goes against the spirit of opening up crowd funding as an alternate funding resource for start-ups, feel people in the industry.

Kataria explains, “If, for instance, a proposal gets 200 retail investors, with the limit of investing at Rs 60,000, the optimal funding which can be raised from these retail investors now comes to a mere Rs 1.2 crore. The start-up will again be at the mercy of institutional investors or QIP’s (qualified institutional placement) to complete its remaining investment target.”

Echoing the same line of thought is Varun Sheth, CEO of Ketto, a crowd funding platform for social causes. He believes capping investment amount pushes investors to have a spray-and-pray model. “Most individuals with a portfolio size of say Rs 6 lakh would rather smartly invest in three companies rather than ten.”

Start-ups, he further elaborates, require assistance, interims of advisory and connections. An investor who has invested in 10 companies won’t have the time to entertain all of them as opposed to three.

It also restricts the idea of free markets, Sheth notes. “Around 99 percent of investors who make such investments have the financial know-how and are aware of the risks. But you cannot restrict the idea of free markets for the remaining one percent,” he reiterates.

What’s your net worth?

Sebi proposals allow only accredited investors to participate in crowd funding and defines them as qualified institutional buyers, companies with a minimum net worth of Rs 20 crore, high net-worth individuals (HNIs) with a minimum net worth of Rs 2 crore or more and eligible retail investors - a norm viewed as ‘stringent’ by the majority that believes this will defeat basic tenets of crowd funding.

Kataria, however, counters this. For him, it is prudent enough to only allow a specific set of diligent investors to be part of this king of funding, given that start-ups fall into the risk-asset category. “As a concept of crowd funding, anyone and everyone should be able to invest in an idea - proposed guidelines don’t fit in, but have been made stringent to avoid fraudulent activities,” notes Kohli.

Many in the industry believe that these guidelines safeguard interests of investors and entrepreneurs alike. “It will open doors for more people to participate, both as entrepreneurs as well as investors, as the entry barrier is not high and the risk is lower for investors,” says Bahubali Shete, CEO and Managing Director, Connovate Technology Private Ltd. “It will take time for the policy to get matured,” affirms Shete.

To bring crowd funding in a proposed big way in India, Kataria recommends considering other entities. “These may include potential international equity crowd funding platforms with established technological as well as market bandwidth and are keen to enter the Indian equity crowd funding market,” he adds.