[Mohammad Kaif is a penultimate year student at Campus Law Centre, Faculty of Law, University of Delhi]
Crowdfunding has become increasingly popular as a way to raise funds, where numerous individuals invest in a project or a company, usually via an internet-based platform. Some companies have used crowdfunding platforms to issue securities in violation of the provisions of Private Placement, regulated by section 42 of the Companies Act 2013. This post analyses a recent order by the Ministry of Corporate Affairs (MCA) regarding the use of Tyke, a crowdfunding platform, for raising funds through the issuance of Compulsorily Convertible Debentures (CCDs).
Tyke’s Services
Tyke is a platform that provides various services to companies, including facilitation towards raising capital transactions and access to its community of member companies. The company must go through KYC verification and diligence on its business model before executing a service agreement with Tyke. Tyke charges an on-boarding fee and a service fee on the amount transferred in the escrow account by community members. Tyke also allows companies to showcase their business through “Ask Me Anything” sessions accessible to its community members, who can communicate their investment intentions and park their investment amount in their virtual escrow account. Tyke supports the setup of the company’s escrow account, third-party KYC verification and private placement compliances. Upon compliance with private placement requirements, the proposed investment amount is remitted to the company’s separate bank account, and securities are allotted to each investor. Tyke charges a service fee calculated as a percentage of the amount raised from investors, ranging from 1% to 4%.
Case Analysis
The MCA order dealt with two companies, Anbronica Technologies and Relate Communication, that used a crowdfunding platform called Tyke to issue CCDs. The MCA noted that the website of Tyke was used by the company as a media/marketing/distribution channel/agent to inform the public at large about the issue of securities and Tyke collected its fees/commission at various stages from the company. The MCA observed that this use was in violation of section 42(7) of the Companies Act, 2013, which prohibits companies from using media or marketing channels to inform the public about the issuance of securities.
The companies submitted that they had only availed the value-added services provided by Tyke, which included the facilitation of connecting like-minded people and investing after the KYC verification people who showed interest in the company. The company connected with persons who showed interest in their business on Tyke and were charged a fee for its services. However, the order noted that Tyke also provided end-to-end services for raising investments through its portal, including onboarding services and charging a commission/fee at the time the amount was deposited by the investor in the virtual escrow account of the company.
The MCA noted that section 42 of the Act provides that private placement shall be made to a select group of persons who have been identified by the Board, and the number of such persons cannot exceed 200. The process of private placement covers the offer, invitation to subscribe, or issue of securities to a select group of persons by a company (other than by way of public offer) through private placement offer-cum-application, which satisfies the conditions specified in the section.
The provision requires the company to adhere to the limit of 200 persons not only with respect to the number of persons who ultimately subscribe to the securities of the company, but also the said number, i.e., 200, cannot be exceeded at the time of making an offer or invitation to offer of the securities of the company.
The company and its promoters/directors were penalized by the MCA for violating section 42(7) of the Act by using the Tyke platform as a marketing and distribution channel for issuing securities. However, despite facilitating the company’s violation, Tyke could not be penalized by the MCA due to the provisions of section 42 of the Act.
Issues Raised by the MCA Order
The MCA order highlights several issues related to the use of crowdfunding platforms for private placements:
Use of third-party platforms for private placement offers
Section 42 of the Act allows private placement offers to be made to a select group of persons, but the use of third-party platforms for such offers raises questions about the identity and eligibility of the investors. Companies must ensure that they comply with the provisions of Section 42 while using crowdfunding platforms for private placements.
Definition of public advertisement under the Companies Act
The order raises questions about the definition of public advertisement and the use of online platforms for private placements. It is unclear whether the use of a third-party platform like Tyke constitutes public advertisement, which is prohibited under the Act.
Over-subscription of CCDs and its implications
The MCA order noted that Tyke’s platform was not restricted to only 200 members, contrary to what was claimed by the company, and that the number of members who showed interest in the company might exceed 200. This raises concerns about the over-subscription of CCDs and the implications for companies that exceed the limit of 200 investors.
Ensuring Compliance when Using Crowdfunding Platforms
Companies must ensure that they comply with the provisions of section 42 while using crowdfunding platforms to raise funds. To ensure compliance, companies can take the following steps:
Conduct proper due diligence on the crowdfunding platform
Companies should conduct a thorough due diligence on the crowdfunding platform before using it to raise funds. This includes verifying the platform’s registration status, checking for any regulatory actions or penalties imposed on the platform, and reviewing the platform’s terms and conditions.
Adhere to the limit of 200 investors
Companies must ensure that the number of investors who participate in the private placement does not exceed 200. This includes the number of investors who ultimately subscribe to the securities of the company as well as the number of investors who are invited to subscribe to the securities.
Avoid public advertisement
Companies should avoid using crowdfunding platforms as a media/marketing/distribution channel/agent to inform the public at large about the issue of securities. This includes avoiding any pitch-related information that is accessible to the public without a login.
Use only value-added services
Companies should use crowdfunding platforms only for value-added services, such as facilitating connections with like-minded investors and conducting KYC verification. Companies should avoid using crowdfunding platforms for end-to-end services that involve the distribution of securities or the collection of funds.
Regulations for Crowdfunding Platforms in India
In India, crowdfunding takes many forms including equity-based crowdfunding, debt-based crowdfunding, fund-based crowdfunding, and peer-to-peer (P2P) lending. Equity based crowdfunding has been banned in India due to multiple scams such as the Sahara scam and the Webwork Trade Links scam, which resulted in significant losses for investors. Fund-based crowdfunding is regulated by the Securities and Exchange Board of India (SEBI) under the SEBI (Alternative Investment Funds) Regulations, 2012. These regulations mandate that crowdfunding platforms be registered with SEBI as Alternative Investment Funds (AIFs) and outlines the conditions and necessities that such platforms must abide by, which includes the eligibility criteria for investors and the maximum limits of investment.
The Reserve Bank of India (RBI) has issued directions for P2P lending platforms in India which requires that such platforms must be registered with the RBI as NBFCs and comply with regulations related to capital adequacy, borrower and investor protection, and reporting requirements. Furthermore, adherence to specific regulations by the RBI might be necessary for crowdfunding platforms including those pertaining to payment gateways, foreign exchange transactions and anti-money laundering measures.
Therefore, companies can ensure compliance when using crowdfunding platforms by ensuring that the crowdfunding platform they use is registered with SEBI and follows the guidelines issued by SEBI and RBI. Companies should also ensure that they comply with the requirements of SEBI’s regulations on private placement of securities under section 42 of the Companies Act 2013.
The Way Forward
The use of a third-party platform like Tyke to facilitate private placement offers may not be illegal per se, but it is essential to comply with the compliance requirements laid down by the MCA to avoid legal action against the company. The MCA order makes it clear that companies cannot use crowdfunding platforms to issue securities in violation of Section 42 of the Companies Act. Companies should conduct proper due diligence on crowdfunding platforms, limit the number of investors to 200, and avoid public advertisement or using end-to-end services that involve the distribution of securities or collection of funds. They should also limit their use of crowdfunding platforms to value-added services only.
Crowdfunding platforms should be mindful of their responsibility in the fundraising process and make certain that they are not enabling any unlawful activities. They need to foster strong relationships with the companies to ensure that all regulatory obligations are met and to provide value-added services that are compliant with legal and regulatory frameworks.
Additionally, the government needs to provide clear guidelines on the use of crowdfunding platforms for private placements, and these guidelines should address the definition of public advertisement and over-subscription of securities. Overall, while crowdfunding platforms offer an innovative way for companies to raise funds, compliance with regulations is crucial to avoid legal penalties and protect the interests of investors.
– Mohammad Kaif
