More power to the crowd

Should you encourage startups to tap into innovative ways of raising money or protect investors from dubious issuers? This is the dilemma global financial regulators have been grappling with in their effort to regulate the crowd-funding of business ventures through social media platforms. The Securities and Exchange Board of India’s recent proposals on crowd-funding leans towards the second horn of the dilemma — the emphasis being on according maximum protection to investors from the risks of funding new ventures. It has framed an onerous set of rules seeking to restrict the type of investors, firms and platforms that may participate in crowd-funding. But crowd-funding is a nascent concept in India; overly restrictive rules can stifle this democratic form of fund-raising.

Take SEBI’s plan of allowing only ‘accredited investors’, defined as institutions, companies, high networth investors (HNIs) and ‘eligible’ retail investors, to take up crowd-funding. Eligible retail investors are those who have a professional adviser, an annual income of ₹10 lakh, pass a professional exam, have filed an income tax return for three years and agree to cap their investments at ₹60,000 or 10 per cent of their net worth. Now, while HNIs have avenues such as venture capital, private equity and angel funds when partaking in new ventures with a minimum limit at ₹1 crore, these are out of reach of the small investor. Crowd-funding is more democratic — it allows investors with modest sums to come together in large numbers to kick-start a new venture. True, startups are risky investments with high failure rates and poor liquidity (the investor can exit only if the business is listed or sold). But this can easily be contained by ensuring that only a small portion of the investor’s portfolio is deployed in crowd-funding. This could be through a monetary limit (₹60,000 or 10 per cent of net worth, as SEBI suggests), while doing away with the other conditions. The disclosures mooted by SEBI — audited financials and a prospectus describing the business plans and promoters — should adequately inform prospective investors of the risks of startup funding. SEBI’s conditions for the firms who can tap this platform also seem too limiting. The ₹10-crore limit on each issuer appears reasonable to curb systemic risks, but the rule on the age (the entity should be less than four years old) is irrational.

Given that crowd-funding is an informal route to raise money, SEBI should not try too hard to throw an overly protective, and ipso facto stifling net over it. In this context, the regulator’s idea that the crowd-funding platforms do their own due diligence on new ventures is a sound one. Shielding investors is all very well, but the real focus should be on getting the right kind of entities to set up crowd-funding platforms. Requiring these platforms to have good systems and experienced people at the helm to curate the ventures seeking public funds may be the best way to harness the power of the crowd, without exposing the investor to too much risk.

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