When the head of a large mutual fund offered me a crore to set up my business and asked for 80% stake in return, I knew there are people everywhere waiting to take advantage of you,” says Arpita Ganesh, co-founder and CEO of Bengaluru-based Buttercups, an online lingerie store that sells custom-made bras. Stuck with ridiculous offers and unable to raise funding through the conventional route for five years, she decided to make a pitch online through crowdfunding platform Wishberry last February. She chose the reward-based model, offering investors her products in exchange for their money.

The campaign got a lukewarm response, but Ganesh was convinced she was on the right track. In a couple of days, she withdrew from Wishberry and moved to a $10 (Rs 600) Wordpress site of her own fitted with a payment gateway. This time, she hit pay dirt: Angel investors loved her idea and pumped in a crore, and soon after, another crore. Not only did she get the money she desperately needed, the campaign also helped her identify a loyal set of customers at no cost.

But Ganesh isn’t a blind votary of crowdfunding, a tool first employed by indie musicians to raise money for recordings, and now used by all manners of fledgling startups that cannot meet the rigid funding criteria of institutional funders (see graphic on next page for various crowdfunding models). Ask her about equity crowdfunding—giving investors equity stakes in a company—and she reacts with horror: “When you have just started, all you have is an idea. You don’t even know how much your equity is worth. You can’t just give it away to random people!”

Equity crowdfunding, a grey area for regulators the world over, is illegal in India as per the norms guiding the private placement of securities in the Companies Act 2013. Meanwhile, in the U.S., the world’s largest crowdfunding market—it has close to 20 major equity crowdfunding platforms, headlined by AngelList which helped fund Uber—the Jumpstart Our Business Startups (JOBS) Act of 2012 legalised it. The Act stipulated relaxed financial reporting norms for firms seeking funding, and removed the pre-existing ban on ‘general solicitation’ of investment in securities without issuing a prospectus-based offer. However, investors are restricted to investing the greater of $2,000 or 5% of their annual income or net worth, if the latter is less than $100,000. Those with an annual income or net worth more than $100,000 may invest up to 10%.

The JOBS Act raised the hackles of investor protection groups, who said it would pave the way for large-scale securities fraud: The International Organisation of Securities Commissions (IOSCO), of which domestic regulator Securities and Exchange Board of India (SEBI) is a member, says crowdfunding campaigns promising financial returns were worth a whopping $6.4 billion in 2013. U.S. regulator Securities and Exchange Commission (SEC) is yet to pass the final framework supporting the Act’s provisions, meaning that though equity crowdfunding is “legal”, campaigns can’t start just yet.

In Britain, another big crowdfunding market, equity crowdfunding is the fastest-growing form of alternative finance, jumping 410% between 2012 and 2014, according to a report by innovation charity Nesta and the University of Cambridge. A Quartz report quotes Britain’s Financial Conduct Authority (FCA) warning investors: “It is very likely that you will lose all your money.” It’s not a hollow doomsday prophecy: In 2011, British soap company Bubble & Balm raised £75,000 from investors in exchange for 15% equity stake on crowdfunding platform Crowdcube. The company folded overnight two years later, leaving investors high and dry. To prevent repeats, the FCA wants investors to certify that they will not invest more than 10% of their portfolio in unlisted businesses, a move that has triggered angry reactions from startups.

Last year the debate reached India, where startups are an increasingly lucrative asset class thanks to the myth of fantastic returns. In June, SEBI released a consultation paper on regulating crowdfunding, especially the equity-based kind. “Uninformed and unsophisticated investors may act with a ‘herd mentality’,” SEBI says in the paper—a chilling throwback to India’s multibillion-dollar chit-fund scam which defrauded thousands of small investors looking for windfalls from a poorly understood industry.

The deadline for sending responses to SEBI expired in July. However, almost a year later, it still hasn’t announced its guidelines. (It didn’t respond to our request for an interview). The delay points at the pressure on SEBI to safeguard investor interest while making sure it doesn’t send a wrong message to the hordes of startups hustling for funds. Regulators are routinely panned for being out of tune with the new Internet economy, adding to SEBI’s dilemma.

A section of the startup community is rallying behind the regulator. “SEBI’s move [to bring regulation] is proactive and in the right direction, provided it strikes the right balance between over- and under-regulation,” says Sijo George, founding CEO of Kochi-based business incubator Startup Village. “Equity crowdfunding is still nascent, and SEBI first needs to define what it is,” he says. Ganesh of Buttercups is more emphatic. “I hope SEBI doesn’t allow equity crowdfunding in India at all,” she says.

Others feel it is too early to have regulations in India. “Canada has 16 million angels for a 30 million population. For 1.2 billion Indians, there are only 1,000 to 1,500 angels,” says Harshad Lahoti, founder of online angel investor network ah! Ventures. Lahoti aims to create 1 million angel investors in India in the next 10 years and worries that overregulation will derail the movement even before it starts.

The imprint of the Jobs Act is clear in SEBI’s paper. For instance, it proposes that only “accredited investors”—qualified institutional buyers and high-net worth individuals—be allowed to participate in equity crowdfunding campaigns. They can transact only via demat accounts used to trade on the bourses. It also proposes that only small, unlisted, and entirely independent companies that are less than two years old be defined as startups that can crowdfund their business. Finally, SEBI proposes allowing only stock exchanges, SEBI-registered depositories, and technology incubators recognised by the government to function as crowdfunding platforms.

Ishita Anand, co-founder and CEO of Delhi-based social-causes platform BitGiving, fears that all this will only aggravate India’s notorious red-tapism. “It is already hard to convince banks to work with crowdfunding platforms. It took me six months to set up a payment gateway,” she says. But she agrees that a policy framework is critical. “One fraud campaign will be enough to make the whole thing crash,” she says.

Satish Kataria, co-founder and CEO of crowdfunding platform Catapooolt, takes exception to some of SEBI’s proposals. “Allowing no more than 200 investors per project and mandating an investing committee to approve projects on the platform are regressive steps. But I understand SEBI is being safe,” he says.

Kataria’s concerns find support in Arjya Majumdar, assistant professor at Jindal Global Law School and an expert on crowdfunding. “SEBI has set the eligibility criteria so high that very few people will actually be able to invest,” says Majumdar. “So I ask: Is the crowd being taken out of crowdfunding?” Majumdar says it is natural for some startups to tank, but it’s the same risk with those who invest in stocks. Equally, it is up to the startups to make sure they don’t give away too much equity too early.

Majumdar points out a crucial area that regulators around the world, including SEBI, haven’t addressed. “Nobody is talking about cross-border crowdfunding,” he says. “For instance, a company registered in the Netherlands that wholly owns a company listed in India can crowdfund itself and use the funds to run the Indian subsidiary. How would SEBI protect investors in those cases?”

The larger question is whether equity crowdfunding can become a scalable alternative to institutional funding in India. Wishberry’s co-founder and CEO Priyanka Agarwal doesn’t think it can. “Many entrepreneurs who run these campaigns here aren’t accountable to investors at all, as is the case with some platforms,” she says.

Venture capitalist Siddharth Talwar of tech VC firm Lightbox also says crowdfunding can never replace venture capital. “With crowdfunding, you can get access to capital, which is great. But you can’t get too much of it. And you will get nothing else,” he says, pointing out that VC firms also bring valuable expertise to the businesses they invest in.

In fact, Talwar argues that crowdfunding is not necessary in India, which has a booming startup ecosystem that everyone wants a piece of. “As an entrepreneur in India, I have access to every VC firm,” says Talwar, “because there are so few of them.”

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