Crowdfunding: Have you thought this through?

Armed with a futuristic idea, startups look at various funding sources to kick start their dream. There are several ways by which you could raise finances for your business and bypass the financial roadblocks.

A platform that has recently gained popularity in India, crowdfunding allows startups to raise finances from multiple small investors. The global crowdfunding industry has generated about $34.4 billion in capital in 2015 and is growing. Indian startups and small investors are also warming up to the concept of crowdfunding, but lack of guidelines from Securities and Exchange Board of India (SEBI) has meant that the segment remains under tapped.

Types of crowdfunding

• Reward based: A reward-based crowdfunding allows a startup receive funds from multiple small investors for a reward. The reward could be either the product or service offered by the startup or any other like a membership or discounts. Startups with a small budget could look at reward-based crowdfunding to get them started or to initiate a prototype of their product.

• Equity based: Under equity based crowdfunding, startups could seek investors and offer in return proportional shares of the company usually through a crowdfunding platform. All such transactions must adhere as per Securities and Exchange Board of India (SEBI) guidelines in accordance with the Companies Act, 2013.

• Donation based: Donation based crowdfunding is apt for startups involved in social sector or charitable projects and humanitarian causes. Contributors invest a small amount for social welfare or as a token gift in such startups.

Advantages and disadvantages of crowdfunding your startup

Like other sources to raise finances for a budding startup, crowdfunding has its positives and negatives. For a startup with limited finances crowdfunding could allow it to start small, make a product prototype and test it with the backers. The company gets an established customer base as those who invest could help the startup plan its marketing strategies. For any new business, a customer base is nothing less than a gold mine.

On the downside, investors are more eager to invest in startups offering a tangible product which they could touch and feel the final offering. Any product or service which is non-tangible may not get adequate investor interest. Crowdfunding norms in India are still under development with the market watchdog SEBI suggesting that fundraising on digital platforms are not recognized under any law, making the investment risky.

SEBI and norms for digital equity crowdfunding platforms (ECP)

SEBI had initiated a consultation paper for crowdfunding platforms in 2014 and has been looking at options to streamline all such crowdfunding companies. Recently the financial watchdog has questioned the legality of equity crowdfunding platforms (ECPs) dampening the spirits of startups and investors alike.

Crowdfunding is a global success. But for Indian startups, unless the operational guidelines are cleared for good with a transparent industry policy, crowdfunding may not be able to generate good funding for a sustainable future.