UNLOCKING THE POTENTIAL OF CROWDFUNDING IN INDIA: A REGULATORY PERSPECTIVE

This article is written by Namandeep Kaur of 3^rd Semester of Rajiv Gandhi National University of Law, Punjab, an intern under Legal Vidhiya

ABSTRACT

Crowdfunding has emerged as a revolutionary financial tool, reshaping how startups, small businesses, and individuals access capital. By enabling people to pool small contributions for creative projects, social causes, or business ventures, crowdfunding has democratized the funding process. This paper delves into the legal and regulatory frameworks that govern crowdfunding platforms, focusing specifically on India. While donation-based and reward-based crowdfunding models have gained significant traction, the prohibition of equity crowdfunding in India poses a limitation to entrepreneurial innovation. The paper also analyzes global crowdfunding regulations, providing a comparative analysis that can guide potential regulatory reforms for India. Key recommendations for India include establishing a unified regulatory framework to streamline the existing multi-layered regulations, promoting financial literacy, integrating blockchain technology for greater transparency, and fostering collaboration among different regulatory bodies. Implementing these measures could help unlock crowdfunding’s full potential in India, driving economic growth, spurring innovation, and ensuring greater financial inclusivity, while simultaneously protecting investors from potential risks.

KEYWORDS

Crowdfunding, Legal Framework, Regulation, India, Equity Crowdfunding, SEBI, RBI, Financial Inclusivity, Investor Protection.

INTRODUCTION

The digital age has transformed the financial world, bringing forth innovative solutions that promote economic growth and inclusivity.[1] One of the transformative advancements is crowdfunding, which has become a game-changing tool for startups, small and medium-sized enterprises (SMEs), and individuals to secure funding through decentralized platforms.[2] As an essential part of FinTech, crowdfunding not only makes capital more accessible but also creates sustainable economic opportunities by overcoming traditional financial obstacles.

SEBI has defined Crowdfunding as:

“Crowdsourced funding involves raising capital for various purposes, such as creative projects (like music, films, or book publications), charitable or public-interest causes (such as community or cooperative initiatives), or business ventures. This is done by gathering small contributions from a large number of individuals, often numbering in the hundreds or thousands. These contributions are typically collected through online crowdfunding platforms, and the campaigns may be promoted through social media channels.”

Further, Crowdfunding is categorized based on deposits, fundraising methods, and business practices that are governed by the regulations of each country. Crowd funding is categorized under widely accepted four types by the IOSCO[3] Research Department. These are:

1. Social Lending or Donation-Based Crowdfunding: Donation-based crowdfunding, often referred to as social lending, aims to gather funds for charitable or social initiatives. Unlike other crowdfunding methods, it does not offer any financial returns to those who contribute. This approach is based on the values of generosity, altruism, and philanthropic support.
2. Reward-Based Crowdfunding: In this type of fundraising, investors receive rewards for their contributions. These rewards can range from coupons and products to memberships or other incentives, which may be available now or promised for the near future.
3. Loan-based Crowdfunding/ Peer to Peer: This form of crowdfunding is referred to as Debt Crowdfunding or Peer-to-Peer (P2P) lending. It entails obtaining loans that are paid back with interest via an online platform that links lenders with borrowers. Borrowers can be either individuals or businesses seeking unsecured loans. The interest rate may be set by the platform, or it could be agreed upon through negotiation between the borrower and the lender. P2P lending enables the collection of funds to assist individuals, startups, and others, making the loan assembly process more efficient.
4. Equity-based Crowdfunding: Equity Crowdfunding is a method of raising capital during the early stages by offering equity shares in return for funding. This approach allows startups and small businesses to obtain financial backing in exchange for a share of ownership in the company.

LEGAL FRAMEWORK GOVERNING CROWDFUNDING PLATFORMS

In India, donation and reward-based crowdfunding are allowed and commonly used to gather funds for social initiatives through platforms such as Milaap, Fuel-a-Dream, Range De, Bitgiving and Wishberry.[4] Peer-to-peer lending, which falls under loan-based crowdfunding, is recognized and overseen by the Reserve Bank of India. On the other hand, the legality of stock and debt crowdfunding, often referred to as securities crowdfunding, remains uncertain. In 2016, SEBI issued a statement declaring that digital equity-based crowdfunding platforms are illegal under the SEBI Securities Contract (Regulation) Act of 1956 (SCRA).[5] This is due to the fact that securities-based crowdfunding involves elements that are governed by both company and securities laws.

Crowdfunding platforms in India connect different stakeholders, including platform providers, aggregators, potential investors, and the general public. These platforms provide advantages such as convenience, streamlined processes, fewer procedural hurdles, and opportunities for marketing. However, the regulatory landscape surrounding crowdfunding in India is complex and multi-layered.

Securities-Based Crowdfunding

Securities-based crowdfunding is a way to raise funds by offering equity through online platforms, but it comes with strict regulatory requirements. When companies want to make public offers, they must issue securities through a prospectus and list them on a stock exchange, which can be expensive and complicated, making it less feasible for early-stage startups. An alternative is private placements, where companies can issue securities to a limited number of investors, capped at 200 per financial year. However, advertising these placements is restricted, and institutional buyers and employees do not count towards this cap.

Equity crowdfunding is not permitted in India. The Securities and Exchange Board of India (SEBI) has banned such activities, considering them violations of the Securities Contract (Regulation) Act, 1956, and the Companies Act, 2013. This ban is intended to reduce risks like fraud and investor exploitation, but it also restricts innovative fundraising options for startups. The prohibition highlights concerns about unregulated activities that could negatively impact investors due to insufficient oversight and the potential for misuse.

Eligibility of Crowdfunding Platforms

Crowdfunding platforms in India face stringent eligibility requirements to ensure their credibility and adherence to regulatory standards. These platforms must be recognized stock exchanges, government-supported technology business incubators, or associations of private equity and angel investors. They are obligated to follow operational guidelines, offer transparent disclosures, and set up effective grievance redressal systems. This framework creates a secure environment for both investors and fundraisers, upholding high levels of trust and reliability. SEBI has defined specific categories for entities that can operate crowdfunding platforms.[6] The first category, Class I, includes recognized stock exchanges and SEBI-registered depositories. Class II comprises government-backed technology business incubators that have been operational for at least five years, possess a minimum net worth of INR 10 crore, and are registered as a society under the Societies Act or as a Section 8 company under the Companies Act. Class III includes associations of private equity and angel investors, which must have a minimum operational history of three years, at least 100 members, capital of INR 2 crore and should be registered under the Companies Act.

Regulation of Peer-to-Peer Lending Platforms

Peer-to-peer (P2P) lending platforms in India are overseen by the Reserve Bank of India (RBI). These platforms are required to follow specific master circulars that outline operational norms, registration processes, and mechanisms for addressing grievances. An Ombudsman system has been set up to help resolve disputes, and these platforms must also comply with the Information Technology Framework for Non-Banking Financial Companies (NBFCs) to maintain safety and efficiency in their operations. These regulations are designed to safeguard both investors and borrowers while promoting responsible lending practices.

SEBI’s Proposed Framework for Crowdfunding

To tap into the potential of crowdfunding, SEBI has put forward a framework in its consultation paper. Only accredited investors, including Qualified Institutional Buyers (QIBs), High Net-Worth Individuals (HNIs), and Eligible Retail Investors (ERIs), can participate, with investment limits set to reduce risks. Companies that can utilize crowdfunding platforms must be unlisted, less than two years old, and not affiliated with larger conglomerates, with a maximum fundraising cap of INR 100 million per year. The platforms are divided into three categories: recognized stock exchanges, government-supported technology business incubators, and associations of private equity and angel investors. Both companies and platforms must adhere to stringent disclosure requirements to ensure transparency and accountability.

Broader Legal Frameworks

In addition to these particular rules, crowdfunding platforms in India must adhere to larger legal frameworks such as the Contract Law, Copyright Laws, Income Tax Act, 1961, Foreign Contributions Regulation Act, 2010, and Information Technology Act of 2000. While privacy policies are required to protect personal information, their efficiency is dubious. The fragmented structure of these regulations frequently creates compliance issues for platforms and enterprises alike.

INTERNATIONAL REGULATION REGARDING CROWDFUNDING PLATFORMS

Crowdfunding regulations around the globe showcase a variety of approaches that seek to balance the need for investor protection with the support of entrepreneurial initiatives. Many nations mandate that crowdfunding platforms secure licenses or authorization to operate legally, which helps ensure adherence to regulatory standards and minimizes the risk of fraudulent activities. For example, in the United States, platforms are required to register with the Securities and Exchange Commission (SEC) under the JOBS Act, while countries in the European Union follow the Markets in Financial Instruments Directive (MiFID). To promote startup growth, some jurisdictions provide exemptions for smaller fundraising amounts, such as the USD 5 million limit in the United States.

Regulatory measures often include fundraising and investment limits designed to mitigate risks for investors. These limits differ by country and are frequently based on an individual’s income or net worth. The United Kingdom, Malaysia, and Australia implement similar strategies, making a distinction between retail and accredited investors to customize protections accordingly.[7] These measures help protect investors from excessive exposure to high-risk ventures while still fostering innovative funding options for small businesses and startups.

Transparency is essential in crowdfunding regulation, with most countries imposing detailed disclosure requirements on platforms and fundraisers. This usually involves providing financial statements, business models, and risk assessments. In both the United States and the European Union, different fundraising thresholds activate varying levels of disclosure obligations. These frameworks are designed to equip investors with enough information to make informed choices, thereby reducing the risks linked to incomplete or misleading information.

Advertising and marketing practices are regulated to uphold ethical standards and ensure that crowdfunding campaigns are accurately represented. Some countries, like Canada, have strict advertising restrictions, while others, such as the United States and the United Kingdom, allow targeted advertisements, especially for accredited investors.[8] These regulations help prevent the spread of misleading or exaggerated claims that could undermine investor trust.

Many jurisdictions also impose capital requirements and measures to protect client funds, safeguarding against platform insolvency and ensuring the security of investor contributions. For instance, countries like Belgium, Germany, and Portugal require that client funds be kept in separate accounts, ensuring they are protected even if the platform encounters financial issues.[9] These safeguards create a safety net that enhances investor confidence while supporting operational stability.

Some nations have developed innovative regulatory frameworks to suit their specific needs. In the United States, the Human Capital Contracts (HCCs) model allows individuals to crowdfund their educational expenses, with investors receiving a portion of future earnings. Meanwhile, Greece has established special licensing requirements for donation-based crowdfunding platforms to prevent misuse. These localized adaptations illustrate how regulations can evolve to address specific economic and cultural contexts while tackling broader issues like fraud and investor protection.

The global landscape of crowdfunding regulation highlights the need for a balanced approach that protects investors without hindering innovation. By creating tailored frameworks that align with local needs and international best practices, countries can cultivate a secure and dynamic crowdfunding environment that benefits all parties involved.

CHALLENGES IN CROWDFUNDING IN INDIA         

Despite its potential, crowdfunding in India is fraught with challenges, both regulatory and operational, that hinder its growth and adoption.

Lack of Unified Regulatory Framework

The lack of a single regulatory framework is a considerable hurdle. Overlapping jurisdictions between the RBI and SEBI result in inefficiencies, cyber fraud, and data breaches. Furthermore, equity crowdfunding is prohibited, which limits entrepreneurs’ capacity to generate funds. The present structures for public offerings, private placements, VCFs, and AIFs do not handle the special needs of crowdfunding. Consumer protection procedures are likewise insufficient. The unresolved Personal Data Protection Bill of 2019 left holes in data protection, and SEBI’s tough rules, although intended to combat frauds, have instead hampered legitimate entrepreneurs.

Cross-Border and Domestic Risks

Cross-border hazards add an extra element of complication. International crowdfunding platforms subject investors to a variety of regulatory requirements, raising the possibility of conflicts and fraud. Within the country, frauds masquerading as charitable gifts or medical assistance attempts damage confidence. Unregulated platforms increase the danger of cybercrime and money laundering. Furthermore, investors frequently confront information asymmetry since they lack the skills to assess economic sustainability, and corporations may make incomplete or inaccurate disclosures.

Operational and Technological Challenges

Operational issues also exist. Crowdfunding securities have no secondary market, making them illiquid and difficult to sell or leave.[10] Technological hurdles, such as online illiteracy and insufficient infrastructure, limit platform operations. Reward-based crowdfunding usually results in conflicts when promised prizes are not provided, thus undermining faith in the system.

Despite these limitations, crowdfunding has the ability to transform financing for startups and small enterprises in India. Achieving this potential needs a balanced regulatory strategy that promotes innovation while protecting investor interests.

RECOMMENDATIONS

To fully harness the potential of crowdfunding in India, a series of well-structured policy and regulatory measures must be adopted. First, India needs a comprehensive and unified regulatory framework for crowdfunding. The current regulatory environment is fragmented, with multiple authorities like SEBI, RBI, and various financial statutes overseeing different aspects of crowdfunding. This disjointed approach creates confusion and inefficiencies. A clear, well-defined regulatory framework, drawing from international best practices while considering India’s socio-economic realities, would provide the necessary legal certainty and encourage responsible crowdfunding activities, including equity-based crowdfunding. Second, financial literacy and digital awareness programs should be introduced to educate both potential investors and fundraisers. Many investors, particularly retail investors, lack awareness of the risks and rewards associated with crowdfunding, leading to either excessive risk-taking or hesitancy to participate. Structured educational initiatives, led by government and private institutions, can help bridge this knowledge gap, ensuring informed investment decisions and fostering a more mature crowdfunding ecosystem. Third, the integration of blockchain technology into crowdfunding platforms can enhance security, transparency, and trust. Blockchain can enable secure, tamper-proof transactions, ensure proper fund allocation, and minimize fraud risks. Smart contracts could be used to automate compliance and regulatory reporting, improving efficiency and investor confidence. Fourth, the government should explore the creation of a secondary market for crowdfunding securities, which would provide liquidity to investors. One of the biggest drawbacks of crowdfunding investments, particularly equity-based crowdfunding, is the lack of exit options for investors. A regulated secondary market would allow investors to trade their stakes in startups and projects, making crowdfunding a more attractive option for retail investors. Finally, regulatory coordination and innovation through sandbox environments are crucial. SEBI, RBI, and other regulatory bodies should collaborate to remove overlapping jurisdictions, ensuring a streamlined and consistent regulatory approach. By implementing sandbox environments, where new crowdfunding models can be tested in a controlled setting, regulators can evaluate innovative solutions without disrupting the existing financial ecosystem. This approach has been successfully implemented in other countries and can provide a pathway for India to develop scalable and robust crowdfunding solutions.

CONCLUSION

Crowdfunding has emerged as a powerful tool for financing startups, small businesses, and social initiatives, offering an alternative to traditional financing methods. In India, while donation-based and reward-based crowdfunding models have gained traction, equity and debt-based crowdfunding face significant legal and regulatory hurdles. The restrictions placed on securities-based crowdfunding stem from concerns about fraud and investor protection. However, global examples demonstrate that a balanced regulatory approach can effectively mitigate these risks while fostering economic innovation.

The current regulatory framework in India is fragmented, leading to inefficiencies, compliance burdens, and limited investor participation. Technological barriers, information asymmetry, and the absence of a clear legal structure further hinder crowdfunding’s growth. However, with proper reforms, India can unlock the true potential of crowdfunding. A well-structured regulatory framework, coupled with financial literacy initiatives, technological advancements like blockchain, the development of a secondary market, and a coordinated regulatory approach, can create a thriving and investor-friendly crowdfunding ecosystem.

By implementing these reforms, India cannot only facilitate entrepreneurial growth but also ensure that crowdfunding becomes a viable and trusted financial tool. This will enable broader financial inclusion, support economic development, and establish India as a leader in digital financial innovation. Balancing investor protection with innovation is key to realizing crowdfunding’s full potential in India’s evolving financial landscape.

REFERENCES

1. Arrena Parveen Ansari, A Socio-Legal Analysis of Crowdfunding in India, MPNLU Law Review, 127 (2022), https://www.mpdnlu.ac.in/assets/pdf/8.%20A%20Socio-Legal%20Analysis%20of%20Crowdfunding%20in%20India.pdf.  
2. Eleanor Kirby & Shane Worner, Crowd-Funding: An Infant Industry Growing Fast, 3 IOSCO SWP (2014), https://www.iosco.org/research/pdf/swp/Crowd-funding-An-Infant-Industry-Growing-Fast.pdf.
3. Garry A Gabison, Understanding Crowdfunding and its Regulation, EUROPEAN UNION (Jan 12, 2025), https://publications.jrc.ec.europa.eu/repository/bitstream/JRC92482/lbna26992enn.pdf.
4. Girija Gadre, “et al”, How crowdfunding works, THE ECONOMICS TIMES WEALTH (Jan. 12, 2025), https://economictimes.indiatimes.com/wealth/earn/how-crowdfundingworks/articleshow/66891983.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst.
5. Jasmine Khan et al, Crowdfunding in India and Its Regulation: A Critical Analysis of SEBI’s Consultation Paper on Crowdfunding, 3 IJLMH 2100 (2020), https://ijlmh.com/wp-content/uploads/Crowdfunding-in-India-and-Its-Regulation-A-Critical-Analysis-of-SEBIs-Consultation-Paper-on-Crowdfunding.pdf.
6. Muna M. Alhammad et al, Review of Crowdfunding Regulations across Countries: A Systematic Review Study, 6 JISEM 1, (2021), https://www.jisem-journal.com/download/review-of-crowdfunding-regulations-across-countries-a-systematic-review-study-11395.pdf.
7. Securities And Exchange Board of India, https://www.sebi.gov.in/media /press-releases/aug-2016/sebi-cautions-investors_33094.html.  (last visited Jan 12, 2025).

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[1] Arrena Parveen Ansari, A Socio-Legal Analysis of Crowdfunding in India, MPNLU Law Review, 127 (2022), https://www.mpdnlu.ac.in/assets/pdf/8.%20A%20Socio-Legal%20Analysis%20of%20Crowdfunding%20in%20India.pdf.

[2] Garry A Gabison, Understanding Crowdfunding and its Regulation, EUROPEAN UNION (Jan 12, 2025), https://publications.jrc.ec.europa.eu/repository/bitstream/JRC92482/lbna26992enn.pdf.

[3] Eleanor Kirby & Shane Worner, Crowd-Funding: An Infant Industry Growing Fast, 3 IOSCO SWP (2014), https://www.iosco.org/research/pdf/swp/Crowd-funding-An-Infant-Industry-Growing-Fast.pdf.

[4] Girija Gadre, “et al”, How crowdfunding works, THE ECONOMICS TIMES WEALTH (Jan. 12, 2025), https://economictimes.indiatimes.com/wealth/earn/how-crowdfundingworks/articleshow/66891983.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst.

[5] Securities And Exchange Board of India,   https://www.sebi.gov.in/media /press-releases/aug-2016/sebi-cautions-investors_33094.html.  (last visited Jan 12, 2025).

[6] Jasmine Khan et al, Crowdfunding in India and Its Regulation: A Critical Analysis of SEBI’s Consultation Paper on Crowdfunding, 3 IJLMH 2100 (2020), https://ijlmh.com/wp-content/uploads/Crowdfunding-in-India-and-Its-Regulation-A-Critical-Analysis-of-SEBIs-Consultation-Paper-on-Crowdfunding.pdf.

[7] Muna M. Alhammad et al, Review of Crowdfunding Regulations across Countries: A Systematic Review Study, 6 JISEM 1, (2021), https://www.jisem-journal.com/download/review-of-crowdfunding-regulations-across-countries-a-systematic-review-study-11395.pdf.

[8] Id.

[9] Id.

[10] Arrena, supra note 1.

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