Crowdfunding As an Emerging Investment Option For Startups

On the global front, the success of crowdfunded startups such as Oculus and Glowforge made people sit up and take notice
Crowdfunding As an Emerging Investment Option For Startups
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Executive Vice-President, National Entrepreneurship Network (NEN), Wadhwani Foundation
5 min read
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Until recently, crowdfunding has been widely perceived to be a process of raising money from the public, i.e., the ‘crowd’, through online forums, social media and crowdfunding websites to finance a cause, mostly a social or impactful cause. Crowdfunding platforms such as Milaap and ImpactGuru are fairly well-known in India and have been looked upon as ‘saviors’ by people on several occasions. ImpactGuru, a crowdfunding platform, raised over INR 15 crore from over 800 COVID-19 related fundraisers to support daily wagers, elderly, healthcare workers, animals and other communities impacted due to the ongoing crisis.

However, apart from social causes, crowdfunding has also become a popular source of raising money for startups over the last few years. On the global front, the success of crowdfunded startups such as Oculus and Glowforge made people sit up and take notice of crowdfunding not merely as a means to support social causes but also to bring alive the dreams of startup founders that are hoping to solve important problems for a diverse set of customers. Closer to home, Swiggy is one such venture that raised its capital through crowdfunding.

Today, crowdfunding is broadly divided into two categories: community crowdfunding and crowdfunding for financial return. While community crowdfunding comprises donation crowdfunding and reward crowdfunding, crowdfunding for financial return comprises peer-to-peer lending (P2P lending) and equity crowdfunding.

While community crowdfunding does not look at any tangible return on the investment made, both P2P lending and equity crowdfunding give investors an option for tangible returns.

In P2P lending, the crowdfunding platform matches the lenders/investors with borrowers. The investors provide the borrowers with unsecured loans at an interest rate set by the platform. In India, the RBI governs this entire mechanism to prevent possible fraud and ensure that all compliances are met. In equity crowdfunding, the investor gets allotted equity shares of the investee company in return for the investment.

The global crowdfunding market was valued at $10.2 billion in 2018 and is expected to reach $28.8 billion by 2025. According to the World Bank’s Crowdfunding Report 2019, the developing world has the ability to deploy up to $96 billion a year by 2025 in crowdfunding investments. Some popular examples of global equity crowdfunding platforms are Equity Net, Syndicate Room, Crowd cube and Seedrs. In India, a case in point is the story of RupeeCircle, a P2P lending platform, which has raised INR 18.12 crore since 2017 and has been giving an annual return of 15-25 per cent to its investors.

Bolstered by such promising data, startups entrepreneurs the world over are now looking at crowdfunding: both P2P lending and equity crowdfunding as options for their startups to be funded with. At the same time, equity funding gives investors on crowdfunding platforms a unique opportunity to not only invest their money for a healthy expected return but also end up owning a chunk of someone else’s business in the process. As part of equity crowdfunding, investors receive equity shares of the company in proportion to the money invested. They also receive a share of the profit as dividend. Though these rewards can be really high if the company that one invests in goes public or there is an exit to another large incoming investor, there’s no guarantee a new startup will succeed, and it may be years before the startup goes public, or a large investor steps in and the investors finally get to sell their shares. If the company fails, the equity shares are rendered worthless.

Crowdfunding as an investment option has also caught the fancy of startups the world over due to factors ranging from the obvious ROI to the more subtle ‘positioning’ angle. A startup investing in a crowdfunding drive to help another startup come to life, not only gives the investor startup a ‘feel-good factor’, but also helps position itself as progressive and collaborative. This is also an opportunity for the startup to enter a playing field previously open only to accredited investors and thus put their analytical and predictive skills to test. They are not unaware that such investments can swing either way, but when were startup entrepreneurs known to shy away from taking calculated risks?

Therefore, every country has its own set of regulations regarding investments through these crowdfunding platforms. Considering the fact that small investors with limited savings may find such risky investments lucrative with the hope that the startup they are investing in would go on to become a blockbuster, equity crowdfunding is prohibited in India by the Securities and Exchange Board of India (SEBI).

While only time will tell whether equity crowdfunding grows exponentially in India, we can safely assume that with the growing popularity of the financial return that crowdfunding options offer the world over, India will need to come up with more balanced crowdfunding regulations that lower the cost of capital and increase liquidity, while ensuring adequate investor protection and minimizing investment risks.

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