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India Venture Capital and Private Equity Report 2014 this asset class, they have a much better understanding.” Another interviewee stated, “As compared to our first fund, we see more participation from family offices and HNIs in the second fund. When I speak to the investors, I also feel that they have a better understanding about the product now. This is good for us because we prefer to have investors who have understood the product rather than one who has not. Many domestic funds and distributors have worked towards educating the HNIs on how this product works and the results are finally showing up.” 5.4 The retail investors The VCPE funds in India are regulated by the Securities and Exchange Board of India (SEBI). Given the nature of the VCPE asset class, SEBI has in recent years formulated regulations to ensure that only those with sufficient ability to analyse and absorb the risk can invest in VCPE funds. For instance, the SEBI Venture Capital Funds (VCF) Regulations (1996) stated that the minimum investment required to be made by an investor is five lakh rupees. 17 However, when SEBI brought out the new regulations to regulate the VCPE funds (called the Alternate Investment Funds [AIF] Regulations, 2012), the minimum amount was substantially increased. The AIF regulations specify that the minimum investment by an investor should not be less than one crore rupees. 18 In 2013, the AIF regulations were amended in 2013 to allow for the creation of a sub-category of venture funds called the angel funds. The minimum investment prescribed in such angel funds was twenty five lakh rupees 19 , which was lower than what was specified for other categories of AIF funds. However, SEBI regulations for angel funds also state that individual investors should have early stage investment experience, or experience as a serial entrepreneur, or be a senior management professional with at least 10 years experience. The investors shall also be required to have tangible net assets of at least two crore rupees, excluding the value of investors' primary residence. Thus, it can be seen that the new norms prescribed under AIF regulations were substantially restrictive for participation by retail investors than what was prescribed under the VCF regulations. In a memorandum to the Board 20 , SEBI stated the rationale for such higher investment levels: "... to ensure that only investors who have prior experience/ adequate awareness of such investments and who have sufficient capital invest in such funds..." It further goes on to state that, "The AIF Regulations require minimum investment by an investor in an AIF of Rs. 1 crore to ensure that only investors with sufficient capacity to do due diligence invest in such AIFs. However, in angel funds, the amount of investments made by the fund is very less and based on our interactions with the industry, most of the investors invest between Rs. 5- 25 lakhs and that too over a period of 3 years. Therefore, since the minimum net assets requirement of Rs. 2 crore (excluding value of primary residence) is expected to ensure that only HNIs are able to make investments in such angel funds, the mandatory minimum investment amount by an investor of Rs. 1 crore in the AIF Regulations is proposed to be relaxed. However, in order to ensure genuine commitment by investors, it is proposed to have a minimum of Rs. 25 lakhs investment in the AIF by every investor to be allowed over a period of 3 years." The current regulatory regime intends to safeguard the ordinary retail investor from investing in such risky asset classes, while at the same time being supportive of the funding requirements of the industry. The existing regulations therefore make it difficult for ordinary retail investors to participate in VCPE fund raisings. The industry has appreciated the higher levels of minimum requirement in the AIF guidelines as this ensures that only knowledgeable and serious investors participate in VCPE fund raisings. However, Future Ventures made an unique attempt to raise capital from retail investors when they launched an IPO for their venture fund operations. Though the IPO was successful, the interest to subscribe for the issue among the retail investors was very less (Exhibit 4). In subsequent years, no other company has made a similar or related attempt to raise capital from ordinary retail investors. However in recent years, there has been a growing interest among retail investors to participate and benefit from the entrepreneurial gold rush. To facilitate their participation new channels have emerged in the West in recent years. Popularly, these have been referred as the crowd funding approach. Though yet to take off in © Indian Institute of Technology Madras 60
India Venture Capital and Private Equity Report 2014 India, the crowd funding phenomenon has grown exponentially in the US and other markets since the 2008 financial crisis. The crowd funding concept If a company needs to raise one crore rupees from the market, there are multiple means to achieve this goal. The well-established (and regulated) paths include issuing stock in the stock market and issuing bonds. But what if the company is unable to qualify under all the regulation required? Is it not possible to raise one crore rupees by raising just one rupee from one crore people? Now consider it from another perspective. For a retail investor, is it possible to invest one Rupee in one hundred companies rather than One hundred Rupees in one company? Welcome to the world of Crowd funding, that connects these two sides. Any individual with a need to raise money (or any company for that matter) with minimal regulation and no previous record can now raise money on crowd funding websites on the internet. Crowd funding has become an umbrella term describing the use of small amounts of money, obtained from a large number of individuals or organizations, to fund a project or a business through an online web-based platform. 21 IOSCO (International Organization of Securities Commissions) indicates four different types of crowd funding – donation crowd funding, reward crowd funding, peer-to-peer lending, and equity crowd funding. 22 The peer-to-peer lending and equity crowd funding have been collectively referred to as financial return crowd funding. An estimated $6.4 billion has been raised till September 2013 since the inception of the financial return crowd funding market in 2006. Being the oldest market, the US accounts for 51% of the global market. This is followed by China at 28% and UK at 17%. China and South Korea make up 95% of the total Asian market. 23 The equity crowd funding segment in the financial return crowd funding, however, is not very large. In the UK, this segment is estimated between $25 to $80 million. There are few platforms that are operating solely in the equity crowd funding platform. Some examples of the sole equity crowd funding platforms are: Syndicate Room, Crowdcube, and Seedrs in the UK; Honglingchuangtou and AngelCrunch in China 24 . A 2013 study indicated the broad demographics of investors in the financial return crowd funding market. The study showed that most of the lenders are between 40 and 60 years, and almost 90% were experienced investors in securities. The median investment size was £50, and the median number of investments is 35, and the median total investment was £2000. The study showed that relatively experienced retail investors invested small amounts of money in a large number of projects. 25 Table 5.2 shows some of the leading platforms in equity crowd funding globally. Table 5.2: Leading crowd funding platforms for equity funding Company Date of inception Equity financed ($, million) Country AngelCrunch 2011 40 China Crowdcube 2010 23.35 UK Seedrs 2013 1.36 UK Banktothefuture.com Limited 2011 1.33 UK Pierrakis and Collins say that crowd funding platforms are essentially for businesses that need to raise an amount of capital which might fall below the radar of VCs or angel investors. Increasingly the traditional sources of risk capital such as venture funds and business angels have started bigger investments in more developed companies. This has created market gaps where crowd funding can play a role. 26 Some of the other benefits of crowd funding are: (a) the ability of the entrepreneur to raise capital without giving up significant equity; (b) spreading of risk through a large number of investors; (c) contribution to economic growth by increasing capital flows to SME’s; (d) cost efficient means of raising capital; and so on. The risks include: (a) the risk of default – in equity crowd funding, the risk of default is estimated be around 50%; 27 (b) risk of closure of the crowd funding platform; (c) risk of fraud because of the anonymous nature of the online activity; (d) risk of illiquidity because of the absence of a secondary market; and (e) lack of transparency and disclosure of risks. © Indian Institute of Technology Madras 61
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