Crowdfunding Hits an Indian Speed Bump

At a time when crowdfunding of new ideas is emerging as an option for small businesses seeking to drive home development and growth, a government department has come up with the lamest of reasons for initiating action against a company for raising equity investment via one of the many crowdfunding platforms. 

The Registrar of Companies (RoC) in Delhi and Haryana has penalized a Delhi-based company of Rs.2 lakh and Rs.1 lakh each on two of its directors for so-called violation of a provision in the Companies Act, a report on the Ministry of Corporate Affairs website says. Of course, this is a one-off case for now. 

What seems to be the real challenge?

The said company raised capital via a technology platform to which the RoC has objected. Its order says that under Section 42 of the Companies Act, enterprises are prohibited from going for private placement of securities and from releasing advertisements or using marketing or distribution channels or agents to inform prospective investors about such an issue. 

In other words, the entire crowdfunding technology platform business that attempts to reach a large number of investors makes it an unauthorized public offer instead of a private placement. What’s more, private placement offers cannot be made to more than 200 persons at a time and anything beyond that number needs to go via SEBI as a public offering. 

Does this push crowdfunding into a dark spot?

In recent times, several small companies looking to raise very small amounts of money towards a new prototype development or creating a hyperlocal business have used these private platforms for crowdfunding. The logic being that people who bet on a technology or a new local business can come together to help the start-up get on its feet. 

The order by adjudicating officer Pranay Chaturvedi says, “The provision requires the company to adhere to the limit of 200 persons not just with respect to the number of persons who ultimately subscribe to the securities of the company, but also the said number, i.e.200, cannot be exceeded at the time of making an offer or invitation to offer of the securities.” 

However, the regulator said in its order that the Companies Act provision dealing with private placements (section 42) does not allow it to impose any penalty on tech platform, in this case Tyke Technologies Private Ltd, which it alleged “clearly facilitated the subject company” in the default of sub-section (7) of Section 42.

Should the platforms be more accountable?

While we know that the government’s concern is around companies seeking investments being bona fide so that investor interests are protected, the challenge here is that use of this existing rule would result in companies not going the crowdfunding route. Instead of putting a penalty on the companies seeking to raise funds, should the platforms do the validations? There are more than a dozen active sources of crowdfunding in the country today. 

Besides bringing together professionals, companies, investors, venture capitalists and startups, and organizing online pitching sessions, the fundraising platforms do identity verification of investors and facilitate setting up escrow accounts for receiving investments. For many small companies, these are quicker and inexpensive options to raise money.

Some investment advisors we spoke to say crowdfunding platforms provide various service offerings and deal structures for different segments so that investors can have a wider exposure to startups and fractional ownership. These rules curtail private placements in such fund raises. Angel funds operate as regulated pooled structures, unregulated ones need to work within the rules that the RoC has now brought up.