I recently came across this article on crowdfunding in the Mint, which is one of the better journalistic coverage of the issue I have read in mainstream media. However, the article kind of missed the biggest challenges faced by the crowdfunding industry in India – so I quickly wrote to the reporter who wrote the piece. Also, I thought, it makes sense to write down the challenges for this blog quickly.
My first contact with crowdfunding happened when I was approached by a serial entrepreneur who was launching a crowdfunding platform (not India specific although he didn’t mind Indian money and projects coming in). The biggest challenge of crowd funding in India is to come up with meaningful reward schemes for the funders which do not violate Indian capital market law which is very strict. Since then, I got to see some corwdfunding projects as an investment lawyer and wrote a couple of articles on the subject as well.
The crowd can not get any interest in the company – no return on investment
Firstly, crowdfunding in India is quite a misnomer. In the USA, if you are funding a company through a crowdfunding platform – you can hope to get some shares in the company and profit from the success of the company. However, this is not possible in India. Here, capital markets law and regulators such as SEBI doesn’t allow raising money from the public in this way with a promise of return on investment of any nature – unless someone can go through the complicated and costly procedure of listing on a stock exchange. And this is for good reason – remember the Sahara case – where the giant conglomerate tried to use legal loopholes to raise money from the public in blatant disregard of the law? SEBI has hence tightened the screws of the system, and it is practically impossible for a startup to raise money from the public – until it becomes profitable and reaches a big scale. The company looking for crowdfunding has little to offer as incentives to the potential funders. Hence they can only hope to get money from people who are willing to donate the money, or perhaps pre-order some products or services being proposed.
In the USA, crowdfunding is a legally recognized capital market transaction – and the investors can get shares in the company they are funding – and therefore profit from the idea becoming successful. USA has made a special law to allow this to support startup companies under the Obama administration. Here is an earlier article you may find useful on this topic: https://blog.ipleaders.in/us-crowd-funding-law-and-development-in-india/
Offering incentives may be seen as offering return on investment
It is an open legal question as to what can be offered to the crowdfunders as incentive – apart from the satisfaction of seeing the proposed idea coming to reality. While pre-ordering should not be a problem – if the value of the products being offered is much higher than the money paid initially, it may be considered return on investment as well. Entrepreneurs looking for crowdfunding, hence, tread a thin line with respect to offering any incentives.
Who ensures that promises are kept?
To get the money out of the crowd, the fund seekers make many sweet promises. What if those promises can not be kept? What if the project fails because the entrepreneur falls seek, or turns out to be not smart enough to execute what he promised? What if he made promises knowing he will never be able to fulfill them? What if money has been raised as pre-orders, and the final product created turns out to be not of a reasonable or merchantable quality? What if a sweet talker makes a lot of promises, raises a hefty fund from the public, and then just run away with the money? What prevents these disasters?
The funding platforms reputation is at stake here – so they could act as a watchdog to a certain extent. However, creating a legal regime with respect to this is much necessary to keep the crooks out of business.
Auditing and accounting of the funds raised
It is necessary that the funders should have a right to know how the funds raised have been used. Why else will they believe in the system if there is no transparency? The future of crowdfunding, even in its charity and donation avatar, pretty much depends on this. The people taking crowdfunding should be subjected to some mandatory accounting standards and auditing. Otherwise some crowdfunded entrepreneurs may end up spending their funds on the much needed vacation.
Role and liability of the funding platforms
The funding platforms are going to be of great systemic importance to the entire crowdfunding ecosystem. We need to ensure that they also follow a set of rules, maintains fairness in the proceedings, and are held accountable for wrong doing. Otherwise, the entire system can fall flat on its face even before it flourishes. The credibility of crowdfunding as a viable medium to fund entrepreneurs can be completely lost unless funding platforms play fair. T
Another related issue which has not been covered in the media for a while is the SME stock exchange – which has so far failed to gather much steam. You can read about it here: https://trak.in/tags/business/2012/08/10/sme-stock-exchange-indian-startup-raise-funds
