Legal problems of crowdfunding in India

What is crowdfunding?


Crowdfunding is a method of collecting money from different investors using social networking sites or online platform for a business venture, project or social cause.  It involves the use of Facebook, Twitter, and LinkedIn etc. to raise money from multiple investors. This was emerged in US & UK and you need to create an online profile for raising funds. This profile will be used to promote the business by sharing it among relatives, friends, peers, friends of friends etc. It is a concept where investor’s money is invested into small ventures through online portals. Crowd funding has achieved massive success since its inception.

In this article, we have summarized the legal problems of crowdfunding in India and its possible solutions.

legal problems of crowd funding in India
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Legal Problems related to crowdfunding


The biggest problem created by crowdfunding is money laundering. The example for this problem is Sahara case. People have started indulging into money laundering activities in the name of crowdfunding. Such activities forced SEBI to frame regulations if crowdfunding involves huge amount of money or is equity based.

Secondly, the interest of investors can be affected negatively because of crowd funding. There is a bigger risk of fraud with the investors because no recourse is given in case of default by borrowers. There is a need of documentation formalities from issuer as per SEBI guidelines but since the cost of this compliance is huge and it takes six to eight months to complete the formalities. The small set ups cannot afford such huge money at the start as a result there are number of non-compliances. The investors cannot trust on issuers because of such risks. The crowdfunding is facing some legal issues in India because there is no legalization provided to equity based crowd funding. Though, it has become legalized in US under JOBS act. This act has restricted the amount of borrowing under crowd funding.

Moreover, the audit of crowdfunding has made a compulsory activity. Such audit will be conducted by CPA and he will take care that all disclosures are made by the company raising funds. The disclosures should be related to utilization of funds and other relevant details of the project. For crowdfunding based on lending, authorization from RBI is required as it comes under its regulations. 

You must have heard regarding certain kinds of crowd funding like pure donation based crowd funding and Peer-to-Peer lending that does not come under the regulatory framework of SEBI. Such kind of crowd funding does not include any security issuing and is lending based crowd funding. These are usually governed by RBI while equity and security related crowd funding will come under the purview of SEBI. The main issue arise here is if more than 50 people are investing in equity form of crowd funding, will it be public offer as per Companies Act & SEBI.  If answer to this question is affirmative, crowdfunding will become more complicated in the start. It will become an expensive venture because in that case you will need to appoint merchant bankers, underwriters, and registrars to handle this project. It will create more complications for startups, due to which entrepreneur may feel frustrated and may try to avoid such issues in the beginning. The economic growth may also get impeded.  

Another issue could be whether the Internet service providers helping in running online portal are intermediaries or not. This answer requires attentiveness of internet companies and look at this issue closely.

Solution to such legal issues


The biggest challenge related to crowdfunding is before the regulators. They need to frame comprehensive regulations that can regulate all kinds of crowdfunding. It will avoid contradictions between various regulators. To give more clarification to crowdfunding ventures, there is a need to introduce expedited legislation.   It has already been legally accepted in US and legislations have also framed to regulate them.

US have already adopted regulations to regulate crowd funding and it is legally accepted by them.  SEBI and RBI should make some efforts to access the needs of stakeholders as it will bring clarity regarding future of crowdfunding in India. There can be seen some serious efforts that are focusing towards making it a mandatory activity under the regulations of India. It is expected that many crowdfunding platforms shall be established in next six months in India.

The platforms such as Wishberry, Ignite Intent have already been developed and further there are many platforms such as Fund lined, Your Seva, The Hot start etc. However, if these complications are reduced, the demand of crowd funding shall increase. The benefits can also be extended to charitable trusts & NGOs etc. from crowdfunding if law requires. Further small budget movies, music albums, documentaries and theatre work producers can also be benefitted through crowd funding. But this method of raising money includes lot of risk, so only those investors should take step further that has tendency to bear the risk.

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