Markets watchdog Securities and Exchange Board of India (Sebi) is miffed with online platforms that enable start-ups to raise equity capital from investors. In a notice issued on 30 August, the regulator has not only made it clear, but also has cautioned investors that it deems such platforms to be in violation of existing laws that govern the domestic securities market.
The notice is brief but leaves little room for ambiguity on how the regulator views the activities of such platforms.
“These digital platforms are neither authorized nor recognized under any law governing the securities market. The electronic platforms are allegedly facilitating investment in the form of private placement with companies, as the offer is open to all the investors registered with the platform amounting to a contravention of the provisions of Securities Contract (Regulation) Act, 1956 (SCRA), and the Companies Act, 2013,” it says.
The notice puts a bunch of online platforms such as Bengaluru-based LetsVenture and Tracxn Syndicate, Chennai-based Termsheet and Pune-based Grex Alternative Investments Market in a fix. Over the past couple of weeks, representatives of some of these platforms have asserted in separate media reports that the notice doesn’t apply to their operations.
In order to better understand whether or not such platforms are indeed in contravention of existing laws, I reached out to LetsVenture and Tracxn with detailed questions on their business models. LetsVenture co-founder Shanti Mohan responded with a “no comment”. Tracxn co-founders Abhishek Goyal and Neha Singh had not responded to the email till the time of going to print.
At the core of Sebi’s displeasure is the private placement route that such platforms use to facilitate investments. As it says in its notice, the regulator deems such private placements to be in violation of the provisions of the SCRA and the Companies Act. Why? Under the existing norms for private placements, a company cannot solicit investments from more than 200 persons within a financial year. The LetsVenture and Tracxn platforms, according to information available on their websites, currently have 1,600 and 500-plus registered investors, respectively. Sebi contends that when a company solicits investment on the platform, the offer is open to all the investors registered with the platform and therefore automatically exceeds the 200-person limit.
One of the questions that I asked both Tracxn and LetsVenture is whether a proposal for funding from a start-up registered on their platforms is visible to all investors on the platform. As stated earlier, neither responded to the questions sent. However, a post in January titled ‘How to raise smart money through LetsVenture’ on the official LetsVenture blog offers some relevant details.
When a start-up registers on LetsVenture, it has to create a profile in two versions—basic and detailed. Once the profile has been created, in both versions, it has three options on how it wants to make the profile visible. Under the first option, dubbed “visible to all”, the basic profile can be seen by all registered users on the platform (this includes users who may not be investors, such as intermediaries). All registered investors, in this case 1,600, can see both the basic and detailed profiles—well past the 200-person limit stipulated for private placements.
Under the second option, limited visibility, the basic profile is visible to all users, including investors, but investors can see the detailed profile only on being given specific access by the company. Finally, in the third option, dubbed “stealth/ private”, neither the basic nor detailed profile is visible to anybody on the platform. Investors can access the profile only after the company solicits interest through a private message.
In choosing the second and third options, companies and investors on the platform are less likely to be in violation of the private placement norms. However, there isn’t enough information available to ascertain how many companies on the platform currently use the two latter options.
Unlike LetsVenture, the Tracxn website doesn’t offer a lot of information on how it currently facilitates fundraising on its platform. However, the website does say: “We showcase up to 2 start-ups every week on the syndicate platform to all registered angels.”
Based on the limited information available in the public domain, it does appear that online platforms such as Tracxn and LetsVenture currently operate in a regulatory grey area.
“In the private placement construct, any solicitation of investment is made on a one-on-one basis. Electronic crowd-funding platforms typically enable a company to solicit investments simultaneously from multiple investors. This makes them more like public exchanges rather than private placements. Therefore, the contention that these platforms are outside Sebi’s jurisdiction is indefensible,” says Divaspati Singh, principal associate at Mumbai-based law firm Khaitan & Co.
There is no doubt that platforms such as LetsVenture and Tracxn provide an invaluable service to the start-up market in terms of easing access to capital that is often hard to come by for young companies with unproven business models. In addition, they do away with the bureaucracy and cumbersome procedures and requirements that usually accompany other sources of capital, for instance, the SME exchanges that are currently operated by the BSE and the National Stock Exchange.
However, it is probably in the larger interest of these platforms, their members and the overall start-up market for these platforms to not continue to operate in what is obviously a very grey regulatory area.
Lessons could be taken from the experiences of online cab-hailing companies which continue to wrestle with regulators. A well-thought-through and extended dialogue with the regulator, in this case Sebi, is certainly in order. The sooner the better.
Snigdha Sengupta is a consulting writer with Mint. She contributes stories on venture capital and private equity.