Chanakya National Law

University

ROUGH DRAFT SUBMITTED IN PARTIAL FULFILLMENT OF PROJECT

FOR THE SUBJECT CORPORATE LAW-I

Role of Stock Exchanges in Trading Of Shares

SUBMITTED TO: Ms. Nandita Jha

(Faculty of Corporate Law I)
Submitted By:
GauravPrakash

ROLL NO. 1020

7th SEMESTER

TENTATIVE CHAPTERISATION

CHAPTER 1 : INTRODUCTION
CHAPTER 2 : MODELS OF CROWDFUNDING
CHAPTER 3 : MODALITIES INVOLVED IN CROWDFUNDING
CHAPTER 4 : CROWDFUNDING IN DIFFERENT JURISDICTIONS A COMPARATIVE
STUDY
CHAPTER 5: LEGAL ISSUES
CRITICISMS, CONCLUSION AND SUGGESTIONS

BIBLIOGRAPHY

INTRODUCTION
CrowdFunding is an internet-inspired means of raising money from the mass market, for a
project or business. It simply means: A continuous and growing series of virtual on-line
auction houses, matching borrowers and lenders; investors and investees; and donors and
donees. There are three parties involved in it: namely Project Campaigner or Entrepreneur,
Website Platformer, and Crowd or Investor as to constitute the business of crowdfunding,
whereas the role of Website Plat former is to bring the other two Parties jointly and they meet
together. Crowdfunding has its origins in the concept of crowdsourcing, which is the broader
concept of an individual reaching a goal by receiving and leveraging small contributions from
many parties whereas Crowdfunding is the application of this concept1. Hence, Crowd
funding, a popular concept started in the US and the UK, is an emerging way of raising
capital, through the use of internet or social networking sites such as Facebook or LinkedIn or
Twitter or even some dedicated websites.
According to the SEBI Consultation Paper on Crowdfunding in India2.
Crowdfunding is solicitation of funds (small amount) from multiple investors through a
web-based platform or social networking site for a specific project, business venture or
social cause.
Crowd sourced funding is a means of raising money for a creative project (for instance,
music, film, book publication), a benevolent or public-interest cause (for instance, a
community based social or co-operative initiative) or a business venture, through small
financial contributions from persons who may number in the hundreds or thousands. Those
contributions are sought through an online crowd-funding platform, while the offer may also
be promoted through social media3.
1 http://www.investopedia.com/terms/c/crowdfunding.asp

2 SEBI (2014), Consultation Paper on Crowdfunding in India, June17, 2014.

(http://www.sebi.gov.in/cms/sebi_data/attachdocs/1403005615257.pdf)

OBJECTIVES:
The objective of the paper is to understand the concept of crowdfunding. It is an attempt in
understanding the present scenario and its legal status in India at large as well as important
aspects of its challenges and its relevancy in India e.g. What are the crowdfunding laws in
India? Is it even legal?
SCOPE OF STUDY:
To promote the startup ecosystem in India, the Securities and Exchange Board of India
("SEBI")

has

rolled

out

'Consultation

Paper

on

Crowdfunding

in

India'

("Consultation Paper") proposing a framework in the form of Crowdfunding to allow

startups and Small abd Medium Enterprises to raise early stage capital in relatively small
sums from a broad investor base. This project is wholly made on the line of mentioned
Consultation Paper on Crowdfunding in India by SEBI.
HYPOTHESIS
The hypothesis proposed by the researcher is that crowdfunding is the recent phenomnnen
and hence it need to be regulated properly for the fact that its growth depends on the proper
regulation. The current paper has highlighted that Consultation Paper on Crowdfunding by
Security and Exchange Board of India(SEBI) regulates laws related to crowdfunding in
absence of any specific legislations.

The paper summaries the highlights of the SEBI

Consultation Paper on Crowdfunding in India and gives a broad outline of its advantages,
lacunas and lacking legal sanctity. It also highlights the contemporary legal environment in
aspect of crowdfunding.
RESEARCH METHODOLOGY
3 Crowd Based Equity Funding Discussion Paper - Corporations and Markets Advisory Committee,
Australia, September , 2013

The methodology of the present project with includes Doctrinal techniques.

In doctrinal method we solve any problem with the help of law. Only with the help of legal
resource, we see legal provisions. We can solve any kind of legal problem by analysing legal
provisions. It is only based on the legal proposition. In which researcher analyze any problem
with the help of law and it is based on the only the written material.
Doctrinal research involves analyze of case law, arranging, ordering and systematizing legal
proposition and study of legal institution through legal reasoning or rational deduction.
In this hotline, we analyze the proposed framework for Crowdfunding as provided in the
Consultation Paper along with the funding opportunity that it provides. As the Consultation
Paper also covers a global study on the subject, we will also analyze herein the framework of
Crowdfunding, as it is prevalent in certain developed economies to better understand the
proposed framework for India.

MODELS OF CROWDFUNDING
There are three models of CrowdFunding to comprehend its concept4, these are:
1. Donation and Reward based:- The platform accepts a donation from many donors for
projects. In most cases, the return is in the form of incentives whether it is in tangible or
intangible form. Hence the return includes finished goods like the pebble watch or a signed
DVD of the movie received by the crowd. Sites like Ketto do this kind of crowd sourcing in
India. In India, this form of model is basically a NGO type model where the donor donates to
done for a charitable or benevolent purpose and in return the donor receives hardly
incentives.
2. Lending Based CrowdFunding:- The borrowers take money with a promise to return it
with certain interests from different people (lenders) and facilitate loans or microfinance to
the needy. This model is used where the Campaigner approaches Lenders through Website
Plat formers and borrow the money. In return, the Campaigner paybacks the borrowed
amount with certain rate of interests as specified by the Lenders. Thus, Milaap is an example
of such crowd sourcing in India.
3. Equity Based CrowdFunding:- This mode of crowdfunding, where investors take a share
of equity in the project or startup, is not legal in India yet. In this model, the Entrepreneur
(the Project Campaigner) approaches the Investors through Website Plat formers to invest in
the project and in return they can hold certain shares of equity in that project or startup.
Equity and reward based crowfunding5 are to areas which must be closely observed and
studied, as both provide a certain sense of return to the investor. Combining equity plus
reward based structures can immensely go a long way in attracting an investor, since in the
4 IOSCO Staff Working Paper - Crowd-funding: An Infant Industry Growing Fast , 2014
http://www.iosco.org/research/pdf/swp/Crowd-funding-An-Infant-Industry-Growing-Fast.pdf

current day scenario, one is always looking to get rewarded for what he has invested, where
donation based structure starts to fade out.

MODALITIES INVOLVED IN CROWDFUNDING

SEBI has emphasized on the following elements while conceptualizing the Crowdfunding
model for India6:
1)
2)
3)

type of entities allowed to raise capital ("Eligible Entities"),

type of investors allowed to invest ("Eligible Investors"), and
type of entities allowed to set up internet based Crowdfunding platforms
("CF Platform") enabling online solicitation from Eligible Investors ("Eligible

Platform Offeror").
1) Eligible Entities: The Consultation Paper proposes that the Eligible Entity has to
be inter alia an 'unlisted public company' incorporated in India, not more than 48
months old, and not promoted, sponsored or related to an industrial group which has a
turnover in excess of INR 250 million (approx. USD 4.16 million) or has an
established business. To ensure that only genuine entities raise funds through this
mode, it is provided that the directors, promoters or associates of the Eligible Entity
should not be suffering disqualifications, inter alia, from regulators such as SEBI and
Reserve Bank of India.
2) Eligible Investors: Only 'Accredited Investors' are proposed to be allowed to invest
via Crowdfunding. "Accredited Investors" includes:
(i)
Qualified Institutional Buyers7 ("QIB"),
5
As per IOSCO Staff Working Paper titled 'Crowd-funding: An Infant Industry Growing Fast',
Crowdfunding is categorized into four categories: (i) donation based Crowdfunding (where issuers
directly seek donation from the grantors), (ii) reward based Crowdfunding (where issuers directly
offers rewards like movie tickets, new computer game, download of a book, etc.), (iii) peer-to-peer
lending (where an online platform matches lenders/investors with borrowers/issuers in order to
provide unsecured loans), and (iv) equity based Crowdfunding (where in consideration of funds
solicited from investors, equity shares of the company are issued).
6
Ibid.
7
SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009

(ii)

(ii) Indian companies and high net-worth individuals having a net worth of
INR 200 million (approx. USD 3.33 million) and INR 20 million (approx.

(iii)

USD 0.33 million), respectively, and

(iii) Eligible Retail Investor (ERI), who is an Indian citizen / NRI complying

with the proposed criteria.

3) Eligible Platform Offeror: SEBI has prescribed certain specific requirements to
check the integrity, experience and solvency of the owners of the CF Platform and the
key members associated with it. In doing so, it has prescribed three classes of entities
(Class I, II and III) to be eligible for offering the CF Platform in India.
Class I entities (stock exchanges and depositories) are already under SEBI's domain
and have a successful track record in securities market;
Class II entities (also referred to as the technology business incubators) have a
specialized domain knowledge in the field of startup mentoring and funding; and,
Class III entities are associations and networks of private equity or angel investors.
CROWDFUNDING IN DIFFERENT JURISDICTIONS A COMPARATIVE STUDY
The Consultation Paper also does a comparative study of prevalent and proposed regimes on
Crowdfunding in different jurisdictions globally. In order to better understand the framework
proposed for India, it may be useful to look at some of the interesting practices adopted, or
proposed to be adopted, by certain countries with respect to the key features of
Crowdfunding:

Regulation of Crowdfunding: Crowdfunding in USA is governed under the Jumpstart

Our Business Startups Act, 2012 ("JOBS Act"). Title II of the JOBS Act deals with
equity offers to accredited investors and Title III deals with crowd sourced equity
funding. Title III of the JOBS Act has not yet come into force. Similar to India,
Australia also hasn't recognized Crowdfunding yet and the Corporations and Market
Advisory Committee of the Australian Government has issued a concept paper and is
currently framing the legislation for equity based Crowdfunding. In UK, a new regime
has been introduced effective from April 1, 2014 whereby two forms of platforms are
recognized i.e. loan

based

crowdfunding

platform

and

investment

based

crowdfunding platform8. Japan also acknowledges equity based crowdfunding

platform9.

Limitation on investment: In USA, in a 12 month period, investors can invest 10% of

their annual income or net worth, whichever is greater, if either their annual income or
net worth is equal or more than USD 100,000. In UK, there is no limit for investors
who are advised by professionals, linked to corporate finance or venture capital firms,
or those certified as high net worth and for other investors, the limit is 10% of their
assets (excluding homes and pensions). In Canada, a maximum investment of $2,500
is allowed in a single investment and $10,000 per year.

Limitation on capital raise: In a period of 12 months, USA allows a maximum limit

is USD 1 million, UK allows EUR 2.5 million and Canada allows $1.5 million. In
Australia, it is proposed at $2 million in a 12 month period.

Restrictions on the secondary market: Several jurisdictions lay restrictions on a

secondary market of securities issued through Crowdfunding10. In USA, the lock-in
applicable is 1 year after the date of purchase, except when transferred: (i) to the
issuer of securities; (ii) to an accredited investor; (iii) as part of an offering registered
with the Securities Exchange Commission; or (iv) to a family member of the
purchaser or equivalent. In UK, for getting a return on investment, investors will need
to wait until sale of the company occurs or a management buyout or floatation occurs.
The Consultation Paper proposes that the securities can be transferred by an investor
if transferred to (i) the issuer; (ii) another accredited investor registered with the CF
Platform; or (iii) a family member or relative or the equivalent11.

8
Arkin v Borchard Lines Ltd and others [2005] EWCA Civ 655
9
Financial Instruments and Exchange Act 2014
10
http://www.sec.gov/news/pressrelease/2015-49.html
11
http://www.lawgazette.co.uk/law/practice-points/litigation-crowdfunding/5048431.fullarticle

LEGAL ISSUES
There are legal issues around crowd funding in India, since equity-based online crowd
funding is not legalized in India yet. It was made legal in the US recently when the Jumpstart
Our Business Startups Act (JOBS) act was passed. Some of the key points of this Act are:
The JOBS Act has put much restriction on the amount that can be borrowed via crowd
funding.
The Act has put an audit compulsion by certified public accountant in some cases of crowd
funding. Disclosures need to be made by the company raising funds and utilizing it.
The company needs to explain everything about its project for which it is raising funds. The
fund utilization plan needs to be disclosed.
The provisions in the existing legal framework for raising funds by companies are regulated
under Companies' Act 2013 and Securities Act i.e. SEBI Act, 1992, Securities Contracts

(Regulation) Act, 1956, Depositories Act, 1996. Raising of pooled managed investment funds
by various entities such as Alternative Investment Fund (AIF), Mutual Fund (MF) etc. is
regulated under Securities Laws. Certain types of crowdfunding such as Pure Donation Based
Crowdfunding and Peer-to-Peer lending do not fall within the regulatory purview of SEBI, as
they do not generally involve issuance of securities for financial return, and may require
authorization from other regulators12. For example, Peer-to-Peer lending may fall under the
purview of Reserve Bank of India. The Reserve Bank of India is yet to bring about any
circulars to give clarity to such P2P lending though it has acknowledged the important role it
can play in the context of changing financial markets13. Therefore, while equity and security
related crowdfunding will be governed by SEBI, lending based crowdfunding will be
governed by RBI. For Pure Donation Based Crowdfunding statutes like Foreign Contribution
Regulation Act, 2010 may also come into play. The major issue will be if a crowdfunding by
more than fifty people in the form of equity crowdfunding will amount to public offer under
Companies Act, 2013 and SEBI (Issue of Capital and Disclosure Requirements) Regulations,
2009 or not? If the answer by regulators is in the affirmative it will needlessly make the
process complicated and cumbersome for start-ups. The process more than anything else will
make crowdfunding an expensive and complicated affair due to the requirement of appointing
merchant bankers, underwriters and registrars to the issue. The issue will deter and impede
economic growth as most entrepreneurs will want to avoid these legal complications for
early stage start-ups. The other issue would be that there cannot be any contradictions
between these several legislations when they do get notified. A consolidated law to govern
crowdfunding will be the manna from heaven to ameliorate the process of funding for startups by decreasing legal fees. Another issue will be if internet service providers who facilitate
the crowdfunding would be intermediaries regulated by SEBI or not? This will be something
that some internet companies will be closely looking at.

12
http://crowdfundingdeepimpact.in/
13
RBI (2014) ,Financial Stability Report,June 26,2014(https://rbi.org.in/scripts/PublicationReportDetails.aspx?
UrlPage=&ID=792)

Out of these, the Consultation Paper proposes to explore the Security Based Crowdfunding
model for India; since, issuance of securities is within the regulatory domain of SEBI. SEBI
has explored the following options under this model:

Equity based Crowdfunding ("EbC"): Eligible Entity can raise upto INR 100 million
(approx. USD 1.66 million) by issuing equity shares to Accredited Investors,
provided, no single investor shall hold more than 25% stake in the Eligible Entity, and
the promoters of the Eligible Entity maintains a minimum of 5% equity stake for at
least 3 years.

Debt based Crowdfunding ("DbC"): Eligible Entity can raise upto INR 100 million
(approx. USD 1.66 million) by issuing debentures or debt securities to the Accredited
Investors in compliance with the conditions provided under the Companies Act, 2013
("CA 2013").

Issuance process under EbC and DbC: It appears that the Eligible Entity will have to
largely comply with the requirements for private placement of securities provided under
CA 2013 and the rules therein. However, one significant diversion from section 42 of CA
201314 makes the Crowdfunding model helpful, i.e. the Eligible Entity can make
invitation to subscribe to a wide base of Eligible Investors in a cost effective manner
without making any public offer.

CONCLUSION
Thus, conclusion can be drawn that there is no doubt that crowd funding is rapidly being
looked as a serious way of raising funds for startups and new businesses in India. However,
there are serious concerns which one needs to ponder upon as: 1) While on one hand, it
perhaps bit derogatory to seek community help for their project; on the other, most of them
still dont know what a crowd-funding campaign entails and wrongly perceive it to be some
type of magic potion which can give instant results. 2) India, the prominent categories are
still largely restricted to either NGO causes or entertainment projects. Why arent these
platforms looking at encouraging other categories onto this domain? Crowdfunding will be a
14
Prospectus and Allotment of Securities Rules, 2014 under Section 42 of CA 2013

much needed elixir for star-ups if the regulators manage to keep things uncomplicated. A lot
of Section 8 companies (not-for-profit), charitable trusts and NGOs/NPOs can benefit
immensely out of crowdfunding if it is extended to them by law. Furthermore, a huge
beneficiary will be art and culture related ventures such as movies, music albums,
documentaries and theatre production. While such entities will only be required to comply
with say provisions similar to Section 42 of Companies Act (private placement), 2013 yet
they will be able raise money from hundreds of persons like a public issue.
The biggest challenge for regulators will be forming a comprehensive legal framework for all
types of crowdfunding, so that there is no contradiction or ambivalence among several
Regulators. It is also a great need for the hour to have expedited legislation on this matter to
give clarity to those who are already crowdfunding their ventures. Further, there is a need to
assess if at all crowdfunding requires the sudden attention that it is receiving given the impact
of other sources of raising funds like the SME Platforms in Stock Exchanges, Private
Placements, Angel Funding and Alternative Investment Funds or will it become a proverbial
storm in the teacup. Consequently, the SEBI and RBI should assess the needs of the
stakeholders and bring out some clarity to what the future holds for Crowdfunding in India.
Therefore, to conclude by saying that one not only needs to focus on the grey legal areas but
on the other said aspects so that crowdfunding platforms should be more trustable,
transparent and democratic in nature with the fund raisers and project campaigners.

Bibliography
1. Consultation Paper on Crowdfunding in India released by Security and Exchange
Board of India
2. E Kirby and S Worner, Crowdfunding an infant growth industry growing fast
3. A.Mohan, R.Pahwa and P. Pranjal, , Crowdfunding is India Ready?, Company
Law Journal 2015
4. CA 2013
5. http://www.sebi.gov.in/cms/sebi_data/attachdocs/1403005615257.pdf