Crowdfunding in India: Some Reflections

• Author: Mr. Lalu John Philip
• Position: Associate, M&A Team, Luthra & Luthra Law Offices, Bangalore.

The Internet, that great leveller of information asymmetries and traditional barriers, has also revolutionized the way business is conducted. Often, legal reforms necessary to fully tap the potential of the internet proceed at a snail’s pace, limiting the natural benefits that may have otherwise emanated from the net. One such instance is the current company law provisions that prohibit entrepreneurs and small start ups from raising capital through the internet. This practice of raising capital through the internet, known as crowdfunding, is slowly gaining acceptance around the world. On April 5th2012, the United States passed the Jumpstart Our Business Startups Act (“JOBS Act”), Title III of which contains provisions recognizing crowdfunding as a legitimate mode of raising capital. Once the regulations under the JOBS Act are framed by the Securities Exchange Commission (“SEC”), crowdfunding is widely expected to become a popular method for raising capital by start- ups in the United States.

Concept of Crowdfunding

There is no universal definition of crowdfunding. The term itself seems to have come from ‘crowd sourcing’, a process where companies ‘outsource’ tasks to internet users around the world. As used in this article, the term crowdfunding means the process by which entrepreneurs raise small amounts of capital for their start-ups (“Issuers”) through the internet from a large number of individuals (“Funders”) who are given equity interest in the start-up.

The latter part of the above definition distinguishes crowdfunding as used in this article from a ‘patronage crowdfunding’ where Funders contribute money without expecting anything in return. On the other hand, if Funders contribute capital in return for a financial interest in the Issuer, then such funding is known as investment crowdfunding. When the capital requirement of the Issuer is substantial, patronage crowdfunding may not achieve the desired results.

The process of crowdfunding may be carried out either through an intermediary website or directly by the entrepreneur, although it may be more efficient to avail of the service of an intermediary website which brings together the potential funders and the entrepreneurs. The U.S. Crowdfunding Act has in fact mandated that crowdfunding be carried out through a broker or a funding portal. It is therefore necessary that any framework of law which seeks to permit and regulate crowdfunding would also have to make provisions to...