Realizing the potential of equity crowdfunding
Recent news that the Securities and Exchange Board of India (Sebi) is cracking the whip on angel investment networks has grabbed headlines. It is understandable for the market regulator to watch out for investor protection, especially in the aftermath of the Sahara and Saradha scams, and given the peculiarities of the Indian market. But Sebi cannot remain oblivious to the winds of technological innovation blowing across the finance/regulatory arena. It is time Sebi proactively embraced a progressive outlook in sync with the digital era we live in and hastened the process to roll out a regulatory framework for equity crowdfunding in India.
As the start-up ecosystem gradually matures in India, angel investing has steadily emerged as a high-risk asset class over the last couple of years. This includes not just a proliferation of angel networks but also an increase in the number and range of sophisticated investors—from entrepreneurs manning successful ventures of their own, high net-worth individuals, ex-founders and senior professionals to corporate czars. The one common feature in all their resumes would be at least a few investments as an angel. Perhaps in a sign of changing times, Bain Capital, a Silicon Valley venture capital fund, recently announced that it would start investing $2-5 million in a curated list of angel investors who would further invest in start-ups.
That angel investment has grown by leaps and bounds in response to the hardships faced by early stage start-ups in raising funds is obvious to most observers of the start-up ecosystem in India. In contrast, the formal frameworks specifically introduced to provide alternative capital-raising platforms for start-ups such as angel funds, institutional trading platforms on the Bombay Stock Exchange (BSE) and the National Stock Exchange have barely taken off. These are valuable lessons for the regulator to evaluate and then calibrate the road map for equity crowdfunding in India.
When Sebi rolled out a consultation paper in August 2014 inviting comments on a proposed framework to regulate crowdfunding platforms, it was widely expected that it would pave the way for some sort of regulatory framework. But in a volte-face of sorts, it clamped down on electronic platforms facilitating fund-raising activities last year, even as the proposed regulations remained in cold storage. Recent media reports indicate that Sebi is now close to finalizing norms relating to equity crowdfunding.
Ethan Mollick, professor at Wharton, said that “the unique value of crowdfunding is not money, it is community”. Equity crowdfunding is simply harnessing the power of the crowd through a tech (online) platform and soliciting small amounts of funds from multiple investors. The platform acts as an online matchmaker, connecting eligible start-ups and interested investors, with investors getting an equity stake in the start-up. As with any tech innovation, the potential for misuse of the platform, investor fraud and money laundering looms large but the regulator has to take a holistic view with the twin objective of investor protection and facilitation of capital access at reasonable costs.
Given the unique model that leverages the power of technology to reach out to the crowd, it is time to recognize the platform as a separate class of market intermediary and subject it to specific compliances. This includes prescribing eligibility criteria for investors as well as start-ups, investment thresholds and conditions, disclosure norms, platform operating conditions, especially relating to due diligence, conflict of interest, reporting norms and cybersecurity, besides registration with Sebi. On the investor front, while it is tempting to restrict the pool of investors to a set of accredited investors, it may defeat the raison d’etre of equity crowdfunding. A workable option put in place in other countries that have recognized equity crowdfunding is to permit retail investors based on their net income and net worth and cap all investments on the crowdfunding platform up to, say, 5% of their net income and net worth every financial year.
The definition of start-ups eligible to raise capital through equity crowdfunding should not be so restrictive that it becomes a non-starter. Aspects such as no institutional investment or ties to an existing industrial group with turnover thresholds may be prescribed. Amendments to the company law, especially relating to private placement of securities, are critical to the growth of equity crowdfunding in India.
It is important to frame rules customized for fintech innovations in the digital economy based on how the digital economy works, and not on the rules of the old economy. So yes, conceptually, a crowdfunding platform may appear similar to that of a stock exchange, but that is where the similarity ends.
The crowdfunding market in India is at a nascent phase and clear regulations permitting it will go a long way in nurturing and fostering the growth of start-ups here. Several countries have jumped on to the crowdfunding bandwagon and started regulating this sector. Sebi’s announcement on the setting up of a committee on financial and regulatory technologies earlier this month acknowledges the role of technology as a disruptor in the traditional financial markets and regulatory sphere. It is hoped that the committee members, drawing upon their collective entrepreneurial experience, will help usher in a progressive regulatory framework that nurtures innovation in India.
Sharanya G. Ranga is partner, Advaya Legal, Mumbai.