As the internet has become an integral part of our lives, entrepreneurs increasingly rely on it for fundraising. Entrepreneurs and business owners in India should take several things into account before embarking on this journey. Online fundraising is one of the best ways to raise funds. Find out how it works.
What is crowdfunding?
Crowdfunding is a method for aspiring businesses to raise funds from multiple investors for a specific purpose by using websites and social media platforms. Using the funds collected, you can fund projects such as a new book release, music video, or product launch. These funds can also be used to support charitable and benevolent causes, such as the development of a business or community initiative. They offer a modern alternative to traditional methods of funding, such as borrowing funds from a bank or other financial institution. They provide your business with funds with small contributions that accumulate over time.
In India, there are different types of crowdfunding
- The use of community-based crowdfunding techniques such as social lending provides a legal way for individuals to make contributions without any expectation of return. Donations typically come from artists or organizations seeking financial support for their projects.
- Through pre-order crowdfunding, investors contribute funds to receive an item or service at a later date. Individuals buy a product today knowing they will get it after a certain period has passed, for example.
- Using a reward crowdfunding model: This type of community-based crowdfunding allows donors to donate money with the expectation of receiving a reward later on.
- A form of peer-to-peer lending, crowdfunding for debt matches investors with issuers through the use of the internet. These borrowers can get unsecured loans from the platform at an interest rate determined by the platform. Such transactions are only permitted by NBFCs with licenses in India.
- Online equity crowdfunding refers to the selling of equity interests to investors as an early stage funding method.
What types of online fundraising are legal in India?
SEBI, the Securities and Exchange Board of India, considers equity-based crowdfunding illegal in India. Protecting the interests of investors within the country is the SEBI’s primary objective as it regulates the securities market in India. Equity-based fundraising involves several risks since it is an unregulated investment. Investors who lack the ability to assess risk due to a lack of relevant skills and experience may suffer heavy losses.
Risky investments can be tempting to investors with limited savings in the hope of a higher return. A lack of regulations and a lack of security from issuers, however, hinders the liquidity of other investors. Investors also lack access to hard information in such cases. They cannot conduct due diligence like venture capitalists and other financial institutions.
Angel investors, loans from financial institutions, and private equity are the main sources of funding for startups in India. In order to make a public offering of equity, a business must be commercially viable. Crowdfunding is typically used at the early stages of product development, such as during pilot testing. The investor is not protected by these methods since crowdfunding doesn’t have any rules. However, India has yet to formulate guidelines for minimizing investment risks and increasing market liquidity in such situations.
SEBI’s Guide to Online Fundraising
The SEBI published a document in 2014 titled ‘Consultation Paper on Crowdfunding in India’ which provided guidelines on online fundraising in India. These guidelines include:
- Participants should only be accredited investors
- A minimum of 5% of issued securities must be held by qualified institutional investors
- Contributions from retail investors must range from $20,000 to $60,000, with a maximum number of 200 investors
- Startups less than two years old can hold fundraising drives
- Business plans, financial information, and management information must be disclosed by all participants in the program
- Startups and investors are subject to due diligence by screening committees that have been registered with the SEC.