SEBI has come out with a proposal (pdf) to explore the possibilities of having a security-based crowdfunding framework in India within the existing legal framework. This proposal does not touch up on reward based crowdfunding that is common on platforms like Kickstarter and would apply for to services like LetsVenture. The regulatory authority had mentioned its plans to come up with such a proposal earlier this year.
According to these proposals only accredited investors registered with a crowdfunding platform can invest in equity-based crowdfunding campaigns. Also, only Indian start-ups or SMEs can raise funds through these platforms.
It has also proposed that such campaigns can only be run by SEBI recognized crowdfunding platforms. Apart from the basic due diligence, these platform will have to set up a ‘Screening Committee’ to select companies that can use these platforms. According to the proposal, crowdfunding platforms may charge a nominal fee from the company seeking funds through the platform and from the accredited investors on the platform.
The regulatory authority has also sought public comments on the consultation paper that needs to be e-mailed to Aditya Sarda (email@example.com) or Ankit Goel (firstname.lastname@example.org) on or before July 16, 2014. Here are the key points raised in the proposal
Who can be an investor?
In Indian scenario, considering the necessity to provide alternative funding sources to startups while ensuring that retail investors are not made to bear the risks of these ventures, SEBI has proposed to permit only Accredited Investors to participate in crowdfunding. The proposed accredited investors who may be allowed to invest through crowdfunding platforms are as under:
1: Qualified Institutional Buyers (QIBs) as defined in SEBI (Issue of Capital and Disclosure Requirements) regulations, 2009 as amended from time to time,
2: Companies incorporated under the Companies Act of India, with a minimum net worth of Rs 20 crore.
3: High Net Worth Individuals (HNIs) with a minimum net worth Rs. 2 Crores or more (excluding the value of the primary residence or any loan secured on such property), and of Rs. 20 Crore,
4: Eligible Retail Investors (ERIs):
– who receive investment advice from an Investment Adviser, or
– who avail services of a Portfolio manager, or
– who have passed an Appropriateness Test (may be conducted by an institution accredited by NISM or the crowdfunding platforms),
– who have a minimum annual gross income of Rs. 10 lakhs.
– who have filed Income Tax return for at least last 3 financial years,
– who certify that they will not invest more than Rs. 60,000 in an issue through crowdfunding platform,
– who certify that they will not invest more than 10% of their net worth through crowdfunding. (Net worth excludes the value of the primary residence or any loan secured on such property).
The ERIs must be an Indian citizen or an NRI. Investments by foreign investors shall be subject to guidelines as may be specified by RBI and government of India from time to time.
Net Worth is calculated as the aggregate value of paid up equity capital plus free reserves (excluding reserves created out of revaluation) reduced by the aggregate value of accumulated losses and deferred expenditure not written off, including miscellaneous expenses not written off.
A QIB is required to purchase at least 5 times of the minimum offer value per person as specified in the aforementioned rule. Collectively all the QIBs shall hold a minimum of 5% of the securities issued.
– A company is required to purchase at least 4 times of the minimum offer value per person as specified in the aforementioned rule.
– A HNI is required to purchase at least 3 times the minimum offer value per person.
– An ERI is required to purchase at least the minimum offer value per person. The maximum investment by an ERI in an issue shall not exceed Rs. 60,000. The total of all investments in crowdfunding for an eligible retail investor in a year should not exceed 10% of its net worth.
Who can raise funding through crowdfunding?
– The company should be seeking to raise not more than Rs 10 crore and list them on a SME Platform or main board of a recognized stock exchange. The company should not be more be more than 48 months old and must not be listed on any exchange already.
– The company should not be promoted, sponsored or related to an industrial group which has a turnover in excess of Rs 25 Crores or has an established business.
– The company should engage in non-finance ventures, real estate or in activities which are not permitted under industrial policy of Government of India.
– The issuing company should not be a known defaulter as noted by RBI or CIBIL.
– If the directors or promoters of the existing companies have been prohibited from operating in capital market, then the company cannot use equity-based crowdfunding. The directors should not be disqualified under Companies Act 2013.
– In a period of 12 months there cannot be multiple crowdfunding campaigns by the same company.
– Issuers shall not directly or indirectly advertise their offering to public in general or solicit investments from the public.
– Issuer shall compulsorily route all crowdfunding issues through a SEBI recognized crowdfunding platform.
– Issuers shall not directly or indirectly incentivize or compensate any person to promote its offering.
– Issuers shall provide provisions for oversubscription. This may include maximum oversubscription amount to be retained, which should not exceed 25% of the actual issue size; intended usage of the oversubscribed amount. The total amount retained. including the actual issue size and oversubscription, shall not exceed the limit of Rs. 10 Crores.
Disclosures needed: SEBI has also proposed that a company intending to raise funds through crowdfunding platform should disclose the amount it is looking to raise in a Private Placement Offer Letter. This letter should also describe current venture for which the funds are being raised, issue Size and specified target offering amount and intended usage of funds, description on the valuation of securities offered, past history of funding, history of any prior refusal from any crowdfunding platform, a description of financial condition of the company, ownership details and capital structure & details regarding board and management, among others.
This letter shall be circulated online only to those selected accredited investors registered with the crowdfunding platform and have made a commitment, not numbering more than 200, and excluding QIBs.
Apart from this, the participating companies need to provide bi-annual disclosures to the crowdfunding platform, which inter alia may contain audited financial statements, how funds raised were utilized and any other funding raised, among others.
Restrictions on each form of equity-based crowdfunding
Equity based Crowdfunding (EbC)
– Enables issuers to raise upto Rs 10 crore by issuing equity shares.
– No single investor shall hold more than 25% stake in a company.
– The promoter(s) shall be required to maintain a minimum of 5% equity stake in the company for at least 3 years.
Debt based Crowdfunding (DbC)
– Enables issuers to raise up to Rs 10 crores online by issuing debentures or debt securities.
– The debt securities issued should comply with requirements specified under Companies Act or rules made thereunder applicable to debentures or bonds.
– The issuer shall appoint a debenture trustee to hold the assets on behalf of the investors.
– The issuer shall need to create a Debenture Redemption Reserve (DRR) of 25% of the value of the debentures.
Fund based Crowdfunding (FbC)
– Funds of the accredited investors registered with a recognized platform will be collected online through the platform and pooled under the AIF to invest in shares or debt securities.
– Provide a separate class of funds under Category I AIFs to offer Fund based Crowdfunding as Category I AIF-Crowd Funds. The Crowd Funds can, post registration with SEBI, get displayed on any Crowdfunding Platform set up by either Class I or Class III entities. Funds may not be required to be subjected to the scrutiny of the Screening Committee of the platform.
– The minimum and maximum corpus of such funds would be Rs. 10 Crores and Rs. 25 Crores respectively.
– Such funds will be able to solicit funds online from a maximum of 1,000 accredited investors.
– Requirement of the minimum investment of Rs 1 Crore by every investor for an AIF is also proposed to be relaxed.
– All accredited investors viz. QIBs, Companies, HNIs and ERIs will be able to invest in these funds.
Who can set up a crowdfunding platform?
SEB has proposed that any online offering or issue or sale through the internet can be made only through a SEBI recognized crowdfunding platform.
1: Class I entities
a: Recognized Stock Exchanges with nationwide terminal presence (RSEs)
b: SEBI registered Depositories
2: Class II Entities
a: Technology Business Incubators(TBIs)
– Promoted by Central Government or any State Government through bodies such as NSTEDB (National Science & Technology Entrepreneurship Development Board) under Department of Science & Technology
– Functioning as a society registered under societies act of 1860/or as a non-profit making section 8 company,
– Having at least 5 years of experience,
– Having a minimum net worth of Rs 10 Crores
– Should have attained self-sufficiency
– Should display only those companies which share a common focus thrust areas as the TBI
3: A joint venture of a Class I entity and a Class II entity is also acceptable for setting up a Crowdfunding Platform as this would bring the best of both classes.
To enable Fund based Crowdfunding (FbC), it is proposed that the new class of Crowd Fund AIFs be allowed to be displayed on the platforms launched by RSEs and depositories.
4: Class III entities
a: Associations and Networks of PE or Angel Investors
– with a track record of a minimum of 3 years
– with a minimum member strength of 100 active members from the relevant industry
– which are registered as Section 8 companies under Companies Act 2013 with a paid up share capital of Rs. 2 Crores
SEBI also noted that platforms launched by Class I & Class III Entities can enable the FbC.
It also noted that no entity can raise funds using crowdfunding without channeling their issues through a recognized crowdfunding platform, subject to the approval of Screening Committee.
Proposed rules for crowdfunding platforms
Crowdfunding platforms must play the role of a gatekeeper and take reasonable measures to reduce the risk of frauds. The proposed requirements for these crowdfunding platforms are:
– Conduct screening and basic due diligence of the business of the start-up. However, no amount of due diligence can provide any form of guarantee of the commercial success.
– Conduct background and regulatory checks on the issuers, whole time directors, promoters, shareholders holding more than 20% of equity shares in the company
– Review the information presented by the issuer on the portal’s website to confirm that the information adequately sets out the general features and structure of the security, issuer-specific risks, parties involved, any identified conflicts of interest, and the intended use of funds.
– Conduct due diligence of investors such as net worth requirement and KYC requirement, if any, while maintaining the privacy of the investors.
– Deny access to an issuer if it has reason to believe that the issuer or its offering is fraudulent.
– Maintain a record of all the issues brought by the companies and subsequently the disclosures of the issuing companies and make it easily accessible to the investors.
– Collect and transmit information to SEBI as may be called for.
Rules for setting up screening committees
These committees will be in charge of vetting the issuer before it is listed on a crowdfunding platform. It may have a minimum of 10 people and may follow the following composition:
– At least 40% of the committee should be composed of professional with expertise in mentoring of startups and early stage ventures.
– At least 30% of the committee should be composed of professionals with experience in banking or capital markets.
– Not more than 30% of the committee should be composed of persons of high caliber and qualifications which are nominated by the owner of the crowdfunding portal, but not on its payrolls.
How non-profits can use equity-based crowdfunding
– Category I AIF-Crowd Funds can also solicit funds online through crowdfunding platforms from the registered accredited investors, for deploying them into donation-based crowdfunding.
– The minimum per capita investment can be set at Rs 50,000. The grantor of donation shall not be entitled to any dividend or profit or gain.
Limitations with AIF-Crowd Funds: The Crowd Funds can channel the funds raised from its investors through the platform into various companies. However, units of such funds may be issued only in dematerialized form. In contrast to EbC where the accredited investors directly hold equity of issues and are shareholders of the company and therefore have legal ownership.
The investor may get exit only when there is sale of the company, a management buyout or a floatation of IPO or listing of company on a recognized stock exchange in SME segment or main board. Crowdfunding platforms cannot offer facilities trading of companies displayed on a crowdfunding platform, as then it would be treated as a Stock Exchange.
There will be no secondary market liquidity in such scrips. However investors can transfer these shares under the following cases:
– To the issuer of the security in accordance with the provisions of Companies Act 2013 pertaining to the buyback of securities by unlisted public limited companies.
– To another accredited investor registered with the platform.
– To a family member or relative or friend of the accredited investor or the equivalent.
Taxation: Taxation of funds raised through crowdfunding shall be in accordance with the current tax provisions applicable to the unlisted companies raising funds through equity or debt or an AIF.
SEBI’s role in crowdfunding, which is proposed to provide a cost-effective and efficient method of fund-raising, will mainly be limited to:
– Recognition of the Crowdfunding portals.
– Oversight and regulation of the Crowdfunding market in India.
– Issuance of guidelines/circular regarding information required to be disclosed in Private Placement Offer Letter or on an ongoing basis or requirements of due diligence and screening or any other matter.
– conduct of periodic inspections or audits of Crowdfunding Platforms and enforcement of Crowdfunding Regulations.