MANAGEMENT OF FINANCIAL SERVICES
LESSON 41:
CREDIT RATING: THE PROCESS
Lesson Objectives
• To understand the process of credit rating, mechanism of
credit rating,
Credit Rating Process
The rating process begins with the receipt of formal request
from a company desirous of having its issue obligations rated
by credit rating agency. A credit rating agency constantly moni-
tors all ratings with reference to new political, economic and
financial developments and industry trends. The process/
procedure followed by all the major credit rating agencies in the
country is almost similar and usually comprises of the follow-
ing steps.
1. Receipt of the request: The rating process begins, with the
receipt of formal request for rating from a company
desirous of having its issue obligations under proposed
instrument rated by credit rating agencies. An agreement is
entered into between the rating agency and the issuer
company.
The agreement spells out the terms of the rating
assignment and covers the following aspects:
i. It requires the CRA (Credit Rating Agency) to keep the
information confidential.
ii. It gives right to the issuer company to accept or not to
accept the rating.
iii. It requires the issuer company to provide all material
information to the CRA for rating and subsequent
surveillance.
2. Assignment to analytical team: On receipt of the above
request, the CRA assigns the job to an analytical team. The
team usually comprises of two members/analysts who
have expertise in the relevant business area and are
responsible for carrying out the rating assignments.
3. Obtaining information:. The analytical team obtains the
requisite information from the client company. Issuers are
usually provided a list of information requirements and
broad framework for discussions. These requirements are
derived from the experience of the issuers business and
broadly confirms to all the aspects which have a bearing on
the rating. The analytical team analyses the information
relating to its financial statements, cash flow projections and
other relevant information.
4. Plant visits and meeting with management: To obtain
classification and better understanding of the client’s
operations, the team visits and interacts with the company’s
executives. Plants visits facilitate understanding of the
production process, assess the state of equipment and main
facilities, evaluate the quality of technical personnel and
form an opinion on the key variables that influence level,
quality and cost of production.
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11.671.3
A direct dialogue is maintained with the issuer company as
this enables the CRAs to incorporate non-public
information in a rating decision and also enables the rating’
to be forward looking. The topics discussed during the
management meeting are wide ranging including
competitive position, strategies, financial policies, historical
performance, risk profile and strategies in addition to
reviewing financial data.
5. Presentation of findings: After completing the analysis,
the findings are discussed at length in the Internal
Committee, comprising senior analysts of the credit rating
agency. All the issue having a bearing on rating are
identified. An opinion on the rating is also formed. The
findings of the team are finally presented to Rating
Committee.
6. Rating committee meeting: This is the final authority for
assigning ratings. The rating committee meeting is the only
aspect of the process in which the issuer does not
participate directly. The rating is arrived at after composite
assessment of all the factors concerning the issuer, with the
key issues getting greater attention.
7. Communication of decision: The assigned rating grade is
communicated finally to the issuer along with reasons or
rationale supporting the rating. The ratings which are not
accepted are either rejected or reviewed in the light of
additional facts provided by the issuer. The rejected ratings
are not disclosed and complete confidentiality is maintained.
8. Dissemination to the public: Once the issuer accepts the
rating, the credit rating agencies disseminate it through
printed reports to the public.
9. Monitoring for possible change: Once the company has
decided to use the rating, CRAs are obliged to monitor the
accepted ratings over the life of the instrument. The CRA
constantly monitors all ratings with reference to new
political, economic and financial developments and industry
trends. All this information is reviewed regularly to find
companies for ,major rating changes. Any changes in the
rating are made public through published reports by CRAs.
Rating Methodology
Rating methodology used by the major Indian credit rating
agencies is more or less the same. The rating methodology
involves an analysis of all the factors affecting the creditworthi-
ness of an issuer company e.g. business, financial and industry
characteristics, operational efficiency, management quality,
competitive position of the issuer and commitment to new
projects etc. A detailed analysis of the past financial statements
is made to assess the performance and to estimate the future
earnings. The company’s ability to service the debt obligations
over the tenure of the instrument being rated is also evaluated.
In fact, it is the relative comfort level of the issuer to service
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 obligations that determine the rating. While assessing the
MANAGEMENT OF FINANCIAL SERVICES
instrument, the following are the main factors that are analysed
into detail by the credit rating agencies.
1. Business Risk Analysis
2. Financial Analysis
3. Management Evaluation
4. Geographical Analysis
5. Regulatory and Competitive Environment 6. Fundamental
Analysis
These are explained as under:
I. Business Risk Analysis
Business risk analysis aims at analysing the industry risk, market
position of the company, operating efficiency and legal position
of the company. This includes an analysis of industry risk,
market position of the company, operating efficiency of the
company and legal position of the company.
a. Industry risk: The rating agencies evaluates the industry
risk by taking into consideration various factors like strength
of the industry prospect, nature and basis of competition,
demand and supply position, structure of industry, pattern
of business cycle etc. Industries compete with each other on
the basis of price, product quality, distribution capabilities
etc. Industries with stable growth in demand and flexibility
in the timing of capital outlays are in a stronger position
and therefore enjoy better credit rating.
b. Market position of the company: Rating agencies evaluate
the market standing of a company taking into account:
i. Percentage of market share
ii. Marketing infrastructure
iii. Competitive advantages
iv. Selling and distribution channel
v. Diversity of products
vi. Customers base
vii. Research and development projects undertaken to
identify obsolete products
viii. Quality Improvement programs etc.
c. Operating efficiency: Favorable locational advantages,
management and labor relationships, cost structure,
availability of raw-material, labor, compliance to pollution
control programs, level of capital employed and
technological advantages etc. affect the operating efficiency
of every issuer company and hence the credit rating.
d. Legal position: Legal position of a debt instrument is
assessed by letter of offer containing terms of issue,
trustees and their responsibilities, mode of payment of
interest and principal in time, provision for protection
against fraud etc.
e. Size of business: The size of business of a company is a
relevant factor in the rating decision. Smaller companies are
more prone to risk due to business cycle changes as
compared to larger companies. Smaller companies
operations are limited in terms of product, geographical
area and number of customers. Whereas large companies
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enjoy the benefits of diversification owing to wide range of
products, customers spread over larger geographical area.
Thus, business analysis covers all the important factors related
to the business operations over an issuer company under credit
assessment.
II. Financial Analysis
Financial analysis aims at determining the financial strength of
the issuer company through ratio analysis, cash flow analysis
and study of the existing capital structure. This includes an
analysis of four important factors namely:
a. Accounting quality
b. Earnings potential/profitability
c. Cash flows analysis
d. Financial flexibility
Financial analysis aims at determining the financial strength of
the issuer company through quantitative means such as ratio
analysis. Both past and current performance is evaluated to
comment the future performance of a company. The areas
considered are explained as follows.
a. Accounting quality: As credit rating agencies rely on the
audited financial statements, the analysis of statements
begins with the study of accounting quality. For the
purpose, qualification of auditors, overstatement/
understatement of profits, methods adopted for
recognising income, valuation of stock and charging
depreciation on fixed assets are studied.
b. Earnings potential/profitability: Profits indicate
company’s ability to meet its fixed interest obligation in
time. A business with stable earnings can withstand any
adverse conditions and also generate capital resources
internally. Profitability ratios like operating profit and net
profit ratios to sales are calculated and compared with last 5
years figures or compared with the similar other companies
carrying on same business. As a rating is a forward-looking
exercise, more emphasis is laid on the future rather than the
past earning capacity of the issuer.
c. Cash flow analysis: Cash flow analysis is undertaken in
relation to debt and fixed and working capital requirements
of the company. It indicates the usage of cash for different
purposes and the extent of cash available for meeting fixed
interest obligations. Cash flows analysis facilitates credit
rating of a company as it better indicates the issuer’s debt
servicing capability compared to reported earnings.
d. Financial flexibility: Existing Capital structure of a
company is studied to find the debt/equity ratio, alternative
means of financing used to raise funds, ability to raise
funds, asset deployment potential etc. The future debt
claims on the issuer’s as well as the issuer’s ability to raise
capital is determined in order to find issuer’s financial
flexibility.
III. Management Evaluation
Any company’s performance is significantly affected by the
management goals, plans and strategies, capacity to overcome
unfavorable conditions, staff’s own experience and skills,
planning and control system etc. Rating of a debt instrument
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requires evaluation of the management strengths and weak-
nesses.
IV. Geographical Analysis
Geographical analysis is undertaken to determine the locational
advantages enjoyed by the issuer company. An issuer company
having its business spread over large geographical area enjoys
the benefits of diversification and hence gets better credit rating.
A company located in backward area may enjoy subsidies from
government thus enjoying the benefit of lower cost of
operation. Thus geographical analysis is undertaken to deter-
mine the locational advantages enjoyed by the issuer company.
V. Regulatory and Competitive Environment
Credit rating agencies evaluate structure and regulatory frame-
work of the financial system in which it works. While assigning
the rating symbols, CRAs evaluate the impact of regulation/
deregulation on the issuer company.
VI. Fundamental Analysis
Fundamental analysis includes an analysis of liquidity manage-
ment, profitability and financial position, interest and tax rates
sensitivity of the company. This includes an analysis of liquidity
management, profitability and financial position, interest and
tax rates sensitivity of the company.
1. Liquidity management involves study of capital structure,
availability of liquid assets corresponding to financing
commitments and maturing deposits, matching of assets
and liabilities.
2. Asset quality covers factors like quality of company’s credit
risk management, exposure to individual borrowers and
management of problem credits etc.
3. Profitability and financial position covers aspects like past
profits, funds deployment, revenues on non-fund based
activities, addition to reserves.
4. Interest and tax sensitivity reflects sensitivity of company
following the changes in interest rates and changes in tax
law.
Fundamental analysis is undertaken for rating debt instruments
of financial institutions, banks and non-banking finance
companies.
Credit Rrating of Instruments
Credit rating is the process of assigning standard scores which
summarize the probability of the issuer being able to meet its
repayment obligations for a particular debt instrument in a
timely manner. Credit rating is integral to debt markets as it
helps market participants to arrive at quick estimates and
opinions about various instruments. In this manner it
facilitates trading in debt and money market instruments
especially in instruments other than Government of India
Securities.
Rating is usually assigned to a specific instrument rather than
the company as a whole. In the Indian context, the rating is
done at the instance of the issuer, which pays rating fees for this
service. If it is unsatisfied with the rating assigned to its
proposed instrument, it is at liberty not to disclose the rating
given to it. There are 4 rating agencies in India. These are as
follows:
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CRISIL - The oldest rating agency was originally promoted by
MANAGEMENT OF FINANCIAL SERVICES
ICICI. Standard & Poor, the global leader in ratings, has recently
taken a small 10% stake in CRISIL.
ICRA - Promoted by IFCI. Moody’s, the other global rating
major, has recently taken a small 11% stake in ICRA.
CARE - Promoted by IDBI.
Duff and Phelps - Co-promoted by Duff and Phelps, the
world’s 4th largest rating agency.
CRISIL is believed to have about 42% market share followed by
ICRA with about 36%, CARE with 18% and Duff and Phelps
with 4%.
Grading System
Each of the rating agencies has different codes for expressing
rating for different instruments; however, the number of
grades and sub-grades is similar eg for long term debentures/
bonds and fixed deposits, CRISIL has 4 main grades and a host
of sub-grades. In decreasing order of quality, these are AAA,
AA+, AA, AA-, A+, A, A-, BBB-, BBB, BBB+, BB+, BB, BB-,
B+, B, B-, C and D. ICRA, CARE and Duff and Phelps have
similar grading systems. The following table contains a key to
the codes used by CRISIL and ICRA.
Credit rating is a dynamic concept and all the rating companies
are constantly reviewing the companies rated by them with a
view to changing (either upgrading or downgrading) the rating.
They also have a system whereby they keep ratings for particular
companies on “rating watch” in case of major events, which
may lead to change in rating in the near future. Ratings are made
public through periodic newsletters issued by rating companies,
which also elucidate briefly the rationale for particular ratings. In
addition, they issue press releases to all major newspapers and
wire services about rating events on a regular basis.
Factors Involved in Credit Rating
Credit rating depends on several factors, some of which are
tangible/numerical and some of which are judgmental and
intangible. These factors are listed below:
• Overall fundamentals and earnings capacity of the company
and volatility of the same
• Overall macro economic and business/industry
environment
• Liquidity position of the company (as distinguished from
profits)
• Requirement of funds to meet irrevocable commitments
• Financial flexibility of the company to raise funds from
outside sources to meet temporary financial needs
• Guarantee/support from financially strong external bodies
• Level of existing leverage (borrowings) and financial risk
As mentioned earlier ratings are assigned to instruments and
not to companies and two different ratings may be assigned to
two different instruments of the same company eg a company
may be in a fundamentally weak business and may have a poor
rating assigned for 5 year debentures while its liquidity position
may be good, leading to the highest possible rating for a 3
month commercial paper. Very few companies may be assigned
the highest rating for a long term 5 or 7 year instrument eg
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 CRISIL has only 20 companies rated as AAA for long term
MANAGEMENT OF FINANCIAL SERVICES
instruments and these companies include unquestionable blue
chips like Videsh Sanchar Nigam, Bajaj Auto, Bharat Petroleum,
Nestle India apart from institutions like ICICI, IDBI, HDFC
and SBI.
Derived Ratings and Structured Obligations
Sometimes, debt instruments are so structured that in case the
issuer is unable to meet repayment obligations, another entity
steps in to fulfill these obligations. Sometimes there is a
documented, concrete mechanism for recourse to the third
party, while on other occasions the arrangement is loose. On
such occasions, the debt instrument in question is said to be
“credit enhanced” by a “structured obligation” and the rating
assigned to the instrument factors in the additional safety
mechanism. The extent of enhancement is a function of the
rating of the “enhancer”, the nature of the arrangement etc and
usually there is a suffix to the rating which expresses symboli-
cally that the rating is enhanced e.g. A bond backed by the
guarantee of the Government of India may be rated AAA (SO)
with the SO standing for structured obligation.
Limitations of Credit Rating - Rating Downgrades
Rating agencies all across the world have often been accused of
not being able to predict future problems. In part, the problem
lies in the rating process itself, which relies heavily on past
numerical data and standard ratios with relatively lower usage of
judgment and understanding of the underlying business or the
country economics. Data does not always capture all aspects of
the situation especially in the complex financial world of today.
An excellent example of the meaningless over reliance on
numbers is the poor country rating given to India. Major rating
agencies site one of the reasons for this as the low ratio India’s
exports to foreign currency indebtedness. This completely
ignores two issues – firstly, India gets a very high quantum of
foreign currency earnings through remittances from Indians
working abroad and also services exports in the form of
software exports which are not counted as “merchandise”
exports. These two flows along with other “invisible” earnings
accounted for almost US$11bn in FY 99. Secondly, since India
has tight control on foreign currency transactions, there is very
little error possible in the foreign currency borrowing figure. As
against this, for a country like Korea, the figure for foreign
currency borrowing increased by US$50bn after the exchange
crisis began. This was on account of hidden forward liabilities
through swaps and other derivative products.
In general, Indian rating agencies have lost some amount of
their credibility in the last two years due to their inability to
predict defaults in many companies, which they had rated quite
highly. Sometimes, some of the agencies had an investment
grade rating in place when the company in question had already
defaulted to some of the fixed deposit holders. Further, rating
agencies resorted to mass downgrading of 50-100 companies as
a reaction to public criticism, which further eroded their
credibility. The major reasons for these downgrades are as
follows
Corporate earnings fell very sharply due to persistent
recessionary conditions prevailing in the economy. Many of the
corporate are in commodity sectors where fluctuations in selling
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294
prices of products can be very sharp - leading to complete
erosion of profitability. This problem was compounded by the
Asian crisis, which led to increased competition from cheap
imports in many product categories.
Rating agencies substantially overestimated financial flexibility
of corporate especially from traditional corporate houses. Much
of the financial flexibility was implicit on raising money from
new issues from the capital market, which has been impossible
in the last 3 years.
In the case of finance companies, widespread defaults like CRB
and tightening of regulations made it virtually impossible for
them to raise money in any form. These finance companies had
been in the habit of investing in longer term, illiquid assets by
borrowing shorter term fixed deposits. When the flow of credit
stopped, they faced liquidity problems. These were further
compounded by defaults by some of the companies to which
they had on lent money.
The experience is no different from the international scenario
where reputed and highly experienced rating agencies like
Standard & Poor (S&P) and Moody’s were unable to predict the
Asian crisis and had to face the embarrassment of seeing the
credit rating of South Korea as a country go from A+ to BB+
in a short span of 3 months.
By and large, the rating is a very good estimate of the actual
creditworthiness of the company; however, it is not able to
predict extreme situations such as the ones described above,
which are unlikely to have been predicted by most investors in
any case. Investors should realize that a credit rating is not
sacrosanct and that one has to do one’s own due diligence and
investigation before investing in any instrument. They should
use the rating as a reference and a base point for their own
effort. One good way of doing this is examining the behavior
of the stock price in case the stock is listed. As a collective, the
market is far smarter at predicting problems than any credit
rating agency. Witness the sharp erosion in stock prices of
companies much before their credit ratings were downgraded.
Witness also the fact that foreign currency bonds from Indian
issuers trade at yields lower than countries which have been
rated higher by rating agencies.
Critical Factors Influencing Financing
Decisions: Credit Rating
Kalyani Ramachandran, Faculty Member, ICFAI, Hyderabad
This paper deals with the credit rating services in countries, such
as Japan, the UK, the US, and traces the genesis of credit rating
in India, in general, and CRISIL the credit rating agency in India
in particular. It feels that with the growth in volume and depth
of capital markets in India, the volume credit rating is bound to
increase and thus boost the investors’ confidence.
A prospective investor would naturally like an assessment of
risk involved in his investment for enabling a proper evaluation
of the risk return trade-off. Factors, such as lack of time, lack
of knowledge of the process of security evaluation, lack of
reliable information, etc., could leave any investor wishing for an
agency which would provide an unbiased judgment of risks
underlying the security. In the US, a number of investment
advisory firms, such as Moody’s Investor Services, Standard and
Poor’s (S&P), and Dun and Bradstreet make an ongoing study
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of thousands of securities floated by various corporations and
publish periodically their. ratings of such securities. In India,
the notorious defaults of certain well known companies and
fly-by-night operators which ensued the stock market boom of
1985 led to the setting of the Credit Rating Information
Services of India, Ltd (CRISIL) in 1988, entrusted with the
important task of evaluating the creditworthiness of companies
trying to tap the capital markets through the issue of debt
instruments.
Credit rating is an issue-specific or security specific evaluation of
the credit/ default risk associated with a security and it conveys
to the investor an independent assessment of the borrower’s
expected capability and inclination to service the debt on the due
dates. The following are descriptions of credit rating as given
by a few well known rating agencies.
“Ratings are designed exclusively for the purpose of grading
bonds according to their investment qualities (Moody’s
Investor Services, 1984).”
“Corporate or Municipal debt rating is a current assessment of
the creditworthiness of an obligor with respect to specific
obligation (Standard and Poor, 1984).”
“A corporate credit rating provides lenders with a simple system
of gradation by which the relative capacities of companies to
make timely repayment of interest and principal on a particular
type of debt can be noted (Australian Ratings, 1984).
The above descriptions emphasize the use of credit rating to
assess the probability of timely repayment of principal and
interest by a borrower. It must also be noted that these
descriptions associate credit rating with only debt or bond rating
since credit rating by the very nature of the procedures adopted
under it is more suitable for rating fixed income securities, such
as debts or bonds on the basis of the default risk underlying
them. Default risk, which is a major risk, accompanying the
purchase of a fixed income security is that portion of total risk
that results from changes in the financial integrity of the
investment. Financial integrity changes when the company that
has issued the security moves further away from or closer to
bankruptcy. The weakening of the financial integrity of a firm
triggers a fall in the prices of the firm’s securities, and usually
the loss suffered by an investor on account of the fall in security
prices will be higher than the losses suffered due to actual
bankruptcy. The default risk is essentially determined by the
amount of funds available to the issuer relative to the amount
of funds required to be paid and as modified by the strength
of the security owner’s claim for payment (Francis, 1987).
Objectives and Benefits of Credit Rating
Diagram 1 depicts the various types of credit ratings that are
usually done.
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11.671.3
Bond rating refers to the rating of bonds or debt securities
MANAGEMENT OF FINANCIAL SERVICES
issued by a corporate, governmental or quasi governmental,
body, such as rating of debentures, public sector bonds,
municipal bonds, etc. Equity rating refers to the rating of
equity shares issued by a company. Short-term instruments
rating refers to the rating of short-term debt instruments, such
as commercial papers issued by companies. Customer rating
refers to the assessment of creditworthiness of a customer to
whom credit sales are to be made. Borrower rating requires the
assessment of the ability to repay of a borrower to whom a
grant of loan is under consideration. If the customer or
borrower is a country in which an investment is envisaged or to
which a loan is to be given, the evaluation of the creditworthi-
ness of such a country is referred to as sovereign rating.
The objectives of credit rating are: To (i) provide superior
information to the ‘,investors at a low cost; (ii) provide a sound
basis for proper risk return structure; (iii) subject borrowers to a
healthy discipline; and (iv) assist in the framing of public policy
guidelines on institutional investment.
A rating published by a professional agency is bound to provide
superior information as the evaluation would be unbiased, the
assessment thorough and in depth, and contain a lot of
information not publicly available. Moreover, in terms of the
time and efforts that would be required by an individual in
gauging the risks associated with an instrument, a readily
available score published by a reliable agency is bound to be
cost-effective. Ultimately, since every published rating is a
reflection of the agency’s competence and integrity, the agency
would provide ratings of high quality and reliability that would
facilitate the investment process.
In an efficient market, the return earned on investments must
match the risks associated with them. The availability of
unbiased ratings would directly assist in the formation of such
efficient capital markets. It has been observed in highly
developed markets that bonds with higher ratings can offer
lower rates of returns and those with lower rating have to offer
higher rates of return. Also, as the rating of a bond declines,
the market price starts falling, and this, in turn, pushes up the
effective cost of the bond. A company whose instruments have
been rated and published would follow rational and sound
financial and business policies as the rating agency would keep a
close watch on the company’s management and would not
hesitate to lower the ratings if the circumstances so warrant The
government can also base its guidelines on the types of
securities to be included in the various institutional portfolios
on the ratings published by various agencies. In addition to
these, credit rating can be used as a marketing tool for placement
of debt obligations with the public and can provide increased
liquidity in secondary markets.
It is also important to understand what purposes that debt or
credit rating does not serve:
A rating is not a general overall evaluation of the issuing
Organisation. If a security issued by a firm A is rated lower
than a security floated by a firm B, it does not necessarily mean
that firm A is worse off than firm B. Since credit ratings are
security-specific, the rating assigned can be used only to study
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 the default risk associated with the security and not for any
MANAGEMENT OF FINANCIAL SERVICES
other purpose.
A rating cannot be taken as a recommendation for purchasing,
selling or holding of a security. Decisions to invest in securities
must properly be based on (a) the expected rate of return, (b)
the risks associated with the investment and (c) the risk profile
of the investor. Of these three issues, credit rating only
provides information on one of them, namely, the credit risk
associated with the investment. Hence, rating cannot provide
guidance for buying, selling or holding of securities.
A rating agency does not conduct a comprehensive audit of the
operations of the issuing Organisation. Though the rating
agency does make a complete study of the information made
available by the company and tries to gather data on the various
aspects of the business, it cannot certify that all the information
provided by the company are true and fair.
A rating once issued by an agency does not remain valid for the
entire life of the security. Whenever the risk characteristics of
the security changes, the rating must be reviewed and upgraded
or downgraded.
Most important of all, credit rating does not create a fiduciary
relationship between the rating agency and the users of the
ratings. There is no legal relationship between the agency and
the user.
Credit Rating Information Services of India Ltd
The progressive liberalisation of economic policies which led to
increased number of new projects being set up, coupled with
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the corporate sector’s increasing dependence on primary markets
for mobilisation of funds highlighted the need to set Up a
credit rating agency in India. The year 1985 witnessed a
phenomenal growth in the size of the capital market and an
increasing number of players in both the primary and secondary
markets. However, subsequent huge losses caused by invest-
ments in ventures or which all claims had been made by the
promoters resulted in the inventors shying away from the
capital market. The Credit Rating Information Services of India
Ltd (CRISIL) was set up in 1987 by ICICI, UTI, GIG, and LIC,
with the major objective of restoring the confidence of the
investors in the capital market and to provide unbiased
assessment of the creditworthiness of companies issuing debt
instruments. The other share-holders of CRISIL include the
Asian Development Bank, the State Bank of India, the Mitsui
Bank, the Bank of Tokyo, the Hong Kong and Shangai Banking
Corporation, and the Housing Development Finance Corpora-
tion Ltd. (CRISIL, 198-). CRISIL commenced its operations in
January 1988 and released its first rating in March 1988. As on
September 1990, this agency had rated instruments of 28
manufacturing companies, and 21 finance companies (Eco-
nomic Times, September 1990). The instruments rated by
CRISIL include bonds, non convertible debentures, convertible
debentures (valid till the time of conversion), debenture
portion of equity linked debentures, fixed deposits, preference
shares, and commercial papers (Keya Sarkar, 1987). So far,
CRISIL has not taken up rating of equity shares.
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The rating process adopted by CRISIL culminates in the
attaching of some specified symbols to the instruments. These
symbols are designed to indicate, in a summary form, CRISIL’s
opinion regarding the relative safety of timely payment of
interest and principal on the instruments. The instruments
based on the symbols are divided into three broad categories:
High investment grades; investment grades; and speculative
grades. The symbols used for rating the debentures and the
interpretation to be attached to the symbols are given in table 1.
(CRISIL 198-). The symbols used in rating of other instru-
ments are given in Appendix 1. CRISIL may apply +’ (plus)
or’-’ (minus) signs for ratings from “AA” to “D” to reflect the
comparative standing within the category. Different instru-
ments of the same company could carry different ratings due to
the different characteristics or features of the instruments and
the different indenture provisions.
The rating process of CRISIL begins at the request of a
company. An analytical team assigned the task of rating,
obtains and analyses information, meets the company’s
management and also interacts with a back-up team which
would have collected industry .information. The findings are
submitted to a ratings committee, comprising certain directors
who are not connected with any CRISIL share-holder, decides
on the rating which is communicated to the company. If the
company wishes to present some additional information, it can
do so at this stage. The issuer can also appeal against the rating
and ask for a review. If the additional information provided so
warrant the rating will be reviewed and revised. During the
rating process, strict confidentiality of client information is
maintained and the board of directors of CRISIL does not get
involved in the rating process nor does it know of what ratings
are in progress. Moreover, once a company decides to use the
rating, CRISIL is under an obligation to monitor the rating
over the life of the instrument. CRISIL may change the rating
depending upon new information or developments concerning
the company and any change so effected is made public (CRISIL
198-). The rating process for a new issue is shown in diagram 2.
CRISIL considers the following key factors in its analysis.
(CRISIL, 198-).
a. Business analysis. This covers (i) industry risk (factors, such
as nature and basis of competition; key success factors;
demand supply position; structure of industry; government
policies, etc.); (ii) market position of the company within
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11.671.3
MANAGEMENT OF FINANCIAL SERVICES
the industry (factors, such as market share; competitive
advantages; selling and distribution arrangements; product
and consumer diversity, etc.); (iii) operating efficiency of the
company (factors, such as locational advantages; labour
relationships; cost structure and manufacturing efficiency,
compared to those of competitors, etc.,); (iv) legal position
(such as, terms of prospectus, trustees and their
responsibilities, systems for timely payment and for
protection against forgery/fraud, etc.,);
b. Financial analysis. This covers, accounting quality (over-
statement/ understatement of profits; auditors
qualifications; method of income recognition; inventory
valuation and depreciation policies; off balance- sheet
liabilities, etc.,); (ii) earnings protection (sources of future
earnings growth; profitability ratios; earnings in relation to
fixed income charges, etc.,); (iii) adequacy of cash flows (in
relation to debt and fixed, and working capital needs;
variability of future cash flows; capital spending flexibility;
working capital management, etc.,); (iv) financial flexibility
(alternative financing plans in times of stress, ability to raise
funds; asset redeployment potential etc.,).
c. Management evaluation. This covers (i) track record of the
management, planning and control systems; depth of
managerial talent; succession plans; (ii) evaluation of
capacity to overcome adverse situations; (iii) goals,
philosophy and strategies. While all the above factors are
considered for companies with manufacturing activities, the
assessment of finance companies lays emphasis on the -
297
 following factors in addition to the financial analysis and The factors considered by Capital Market (1986) are divided into
MANAGEMENT OF FINANCIAL SERVICES

management evaluation as outlined above. six categories:

d. Regulatory and competitive environment. This covers (i) I. Promoters
structures and regulatory framework of the financial system;
1. Industry house
(ii) trends in regulation, deregulation and their impact on
the company. 2. Group companies (market price)

e. Fundamental analysis. This covers (i) liquidity management 3. Group companies (EPS)
(capital structure; term matching of assets and liabilities; 4. Existing company (market price)
policy on liquid assets in relation to financing commitments 5. Existing company (EPS)
and maturing deposits); (ii) asset quality (quality of the 6. Auditors qualifications
company’s credit risk management; systems for monitoring
credit; sector risk, exposure to individual borrowers; 7. Experience
management of problem credits, etc.,); (iii) profitability and 8. Qualifications
financial position (historic profits; spreads on fund 9. Age
deployment revenues on non-fund-based services; accretion
II. Project
to reserves, etc,); and (iv) interest and tax sensitivity
(exposure to interest rate changes; hedge against interest rate 1. Product technology
and tax law changes). 2. Collaborators
The entire rating process takes between four to six weeks. 3. Gestation
CRISIL also plans to conduct equity research to provide 4. Location
information to investors and to guide them in their equity
5. Utilities
investment decisions. It also plans to provide additional
information on companies to bankers and financial institutions 6. Labor
and to perform payment record analysis to analyse the credit 7. Cost of project
record of dealers as also their competence in meeting obliga- 8. Cost of finance
tions (Mamta Suri, 1989).
9. Institutional appraisal
The State Bank of India has decided recently that the leasing
10. Other similar project
and hire purchase companies banking with it and wishing to
borrow more than Rs. 50 lakhs must obtain a rating from III. Prospects
CRISIL. The State Bank is insisting on the rating even if it is a 1. Consumer
smaller number of the consortium. The rating will be a one- 2. Present market size
time rating and a fresh rating will be insisted only when the
3. Future market size
borrower asks for a rise in Maximum Permissible Bank Finance
(MPBF) (Chartered Financial Analyst 1989). The Union 4. Competitors
Government, in September 1990, cleared a proposal by the 5. Marketing arrangements
Industrial Finance Corporation of India (IFCI) to set up a 6. Technology obsolescence
second credit rating agency in the country to meet the require-
7. Future projects
ments of companies based in the north (Economic Times,
September 1990). IV. Government Policy
Approaches to Credit Rating 1. Price control/subsidy
In the foregoing analysis, the meaning and scope of credit 2. Import (OGL, etc.)
rating and how CRISIL rates an issue, was discussed. In this 3. Taxation
section, a narration of the usual approaches to the credit rating
4. Government attitude
process and whether quantitative models can be used to carry
out credit rating is given. V. Security Characteristics
The approaches usually adopted for credit rating are: (i) implicit 1. CCI consent
judgmental approach; (ii) explicit judgmental approach; and (iii) 2. Secured/Unsecured
statistical approach.
3. Interest
Implicit Judgmental Approach 4. Capital appreciation
This approach rates a security by considering a broad range of
5. Dividend
factors, some of which may be quantified, and others not
quantified. It is not necessary that all the factors considered 6. Premium
should be specified. The factors covered are weighted and 7. Size of issue
combined in an unspecified manner, and a credit rating is 8. Tax benefits
arrived at. The rating of equity issues by the periodical Capital
9. Liquidity
Market is an illustration of the implicit judgmental approach.

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VI. Miscellaneous Statistical Approach

MANAGEMENT OF FINANCIAL SERVICES

Capital Market assigns a maximum of I 00 points, distributed In both the implicit judgmental and explicit judgmental
among the characteristics mentioned above. Since there are approaches, the rating of a security is based on the subjective
about 40 sub criteria, the total of 100 points is divided among assessment of the rater and hence the final score arrived at could
the sub- criteria at about 2.5 points per sub criterion. As a result be biased. The statistical approach, in contrast uses a statistical
no sub criteria is given undue weightage. Though all the criteria method in selection of factors, the weights to be assigned to
used for evaluation are spelt out, the way in which the criteria are them and in the interpretation of scores. Though the judg-
weighted and combined to form a final score is not explicitly ment of the rater plays an important role in the initial selection
specified. An example of issue rating published by Capital of factors and model specification, the credit rating model that
Market (1990) is given below. finally emerges is based on an objective process and statistical
Company Videocon VCR Ltd. concepts.
Promoters Videocon group in collaboration with Toshiba Corporation Japan
Project Manufacture of VCR/VCP including video tape deck mechanism The steps involved in the statistical approach are as follows: (I)
with a capacity of 8 lakh numbers per annum. A set of factors which are considered to be relevant for rating
Cost of the project Rs. 49.80 Crores.
Present issue Equity shares of Rs. 10 Each for Cash at par 4.45 purposes is defined; (II) A sample of objects (in this case
12.5% Secured redeemable partly convertible 15.25 instruments already issued) is taken and based on historical
debentures of Rs. 250 each
(Offered to public Rs. 4 18 crores) experience, an “a priori” classification of these objects is made;
14% Secured Redeemable non-convertible 15.00 (III) Using an objective statistical method, the credit rating
debentures of Rs. 100 each issued to public
Total 34.70 model is developed. This model shows the factors which are
Credit Rating: 53/100 really relevant the relative importance of these factors and the
The periodical has also made the following observations to manner in which they should be combined to determine the
justify the rating assigned: - credit rating- (iv) The model developed is tested by scoring the
* The company proposes to import most of the raw materials sample of objects already gathered in order to determine the
against yen payment till the company, s phased indigenisation predicting power of the model.
materialises. With the bad balance of payments position and Quantitative Weight X quantitative
Factor Weight
the government’s thinking on conspicuous consumption the assessment assessment
venture is a bold bet; it has opted for a very high debt gearing Networth 7 0.50 3.50
of 5.43 times its equity; it has borrowed Rs.8.85 crores from Current ratio 5 0.75 3.75
Videocon International Ltd as unsecured loan; and the issue Turnover 15 0.60 9.00
Profitability 20 0.40 8.00
prospectus makes no mention of the schedule of the imple-
Business risk 23 0.50 11.50
mentation of the project. Though according to the company
Financial risk 15 0.80 12.00
sources, production would commence within a short time, the Managerial
orders placed for machinery as shown under “material con- 15 0.80 12.00
competence
tracts” amount to only Rs.48 lakhs worth of yen. Overall Credit Score = 59.75

Explicit Judgmental Approach

This approach involves the following: (i) A set of factors which
are considered relevant for rating purposes, is defined; (ii) The
weights which are to be assigned to these factors are also
explicitly specified; (iii) For each of the factors, a quantitative
assessment of the entity to be rated is made; and (iv) The
weights are applied to the quantitative assessment and a
numerical credit score or Index is arrived at.
The illustration given below shows the application of the
explicit judgmental approach.
Illustration. A rating agency considers the following set of
factors and their relative weights for rating a debt instrument
issued by a company. The rater quantitatively assesses each of
the factors listed above on a 0- I scale, and such assessment is
based purely on the judgment of the rater. Combining the
weights with the assessment made, the overall credit score is
derived. Table 2 shows how the final score is arrived at.
Factor Weight
Networth
Current ratio
Turnover
Profitability
Business risk
Financial risk
Managerial competence
The scores as generated by the model are compared with the
actual scores and inferences are drawn about the reliability of the
model. Edward Altman, a leading investment banker in the
US, has developed a Z- score model to predict corporate
collapses. He has used the statistical technique of discriminant
analysis for identifying the financial ratios which are most
important for predicting corporate health and also for assigning
weights to such ratios. The key ratios identified by him cover
profitability, leverage, asset turnaround, and liquidity. Based on
the analysis, the Z- score is arrived at. Research in the US has
indicated that if the Z- score dropped below 1.8, the corpora-
tion would be heading towards bankruptcy (Economic Times,
Jan. 1990). A brief note on discriminant analysis is given in
Appendix 2.
The use of the quantitative models as under the statistical
approach can help in reducing inconsistencies; that is, there is
less chance for different ratings to be assigned by different
ratings to the same instrument. Also, investors can use
7 quantitative models to rate those privately placed debt issues for
5
15
which no ratings are available. However, the quantitative
20 models in exclusion may not always lead to a correct rating as a
23 number of subjective, judgmental and qualitative factors have
15 to be considered in a rating process. A rater can, therefore, use
15

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11.671.3 299
 quantitative models to test his judgment and to reduce India (Bagchi, 1986). According to JCIF, an “A” rated country is
MANAGEMENT OF FINANCIAL SERVICES

inconsistencies in rating. fully capable of servicing existing debt and will be able to
continue to do so for the next four years. It will also be able to
Sovereign Rating
meet any fresh fund requirements. “B” rated countries are also
In recent times, the credit rating of countries or sovereign rating
fully capable of servicing the existing debt but while “A” rated
has assumed a great importance. While rating agencies, such as
countries have the capacity to service a higher level debt than the
Standard and Poor, Japan Centre for International Finance and
existing, the same cannot be said of “B” rated countries. The
the London based Economist carry out periodical studies of
“C” rated countries are also capable of making current debt
the creditworthiness of various countries, lenders and exporters
payments but could have borrowing or debt servicing problems
use such reports to fine-tune the rates at which funds are made
if global financial conditions change. Countries which could
available to the borrowing countries and to add clauses -of
have imminent financing problems are rated by JCIF as “D”,
varying stringency in the export sales agreements. The higher
and those countries which have already run into problems in
the risk associated with a country, the higher the margin charged
servicing their external debt are rated as “E”.
above the bench-mark rates, such as the LIBOR (London Inter-
bank Offered Rate) or the long time prime at which financial Of late, the credit rating of India has taken a beating. In May
institutions are willing to lend or borrow at a particular point of 1990, the rating agency of the US, Standard and Poor, noted
time (Financial Express, May 1990). The Economist follows that the long-term credit rating of India is likely to be “BBB”
the explicit judgmental approach in sovereign rating. The (Financial Express, May 1990). The rating of “BBB” implies
factors considered and the maximum points assigned to each that the country’s borrowing capacity is poor. According to the
of these factors (to reflect their relative importance) are given in rating agency, the country is extremely vulnerable to changes in
table. world oil prices and due to the unfavorable balance of pay-
ments situation, the country is relying more on commercial debt
Sovereign Rating: Factors of
which could further expose it to international market pressures.
Factor Maximum Points Other factors causing the low rating are high monetary expan-
Economic sion leading to increased inflation which exerts pressure on
FallingGDP 8 balance of payments, and the low rate of investment in the
Inflation 5 country.
Capital flight 4 Conclusions
Foreign debt 6 Credit rating in recent times is being looked upon as an
Low food output 4 important investment advisory function. In countries with
highly developed markets, such as the US, and Japan, though
Commodity dependence 6 there is no statutory requirement to have the securities rated, as
Political high as 90 per cent of the securities floated are voluntarily rated
Bad neighbours 3 due to the pressure exerted by investors and bankers. In India,
High authoritarian 7 a beginning has been made with the establishment of CRISIL
and the RBI insisting that all commercial papers prior to their
Staleness 6 issue must be rated. With the growth in volume and depth of
Illegitimacy 9 capital markets and the increasing knowledge and awareness of
Generals in power 6 the investors, it can be expected that voluntary credit rating
War 20 would be on the increase.

Social Appendix I
Crisil’s Credit Rating Symbols For Securities Other Than
Urbanisation 2
Debatures (Based on CRISIL’S Booklet on Rating)
Islamic fundamentalism 4
Corruption 6
Ethnic tension 4
100
For each country a score is assigned for each factor within the
range of zero and the maximum possible points. The scores
for all the factors are added to get the aggregate risk score and
the higher the score, the greater is the risk associated with the
country. The countries, based on the risk scores are also
classified into: Hyper-risk, very high risk, high risk- medium
risk, and low risk categories. In the 1986 risk ranking of
countries the Economist classified India as a medium risk
country with a risk score of 35. In the same year, the Japan
Centre for International Finance (JCIF) gave the rating of G to

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 MANAGEMENT OF FINANCIAL SERVICES
Rating Symbol Interpretation
Fixed Deposits
FAAA-High This rating indicates that the degree of safety regarding timely payment of
safety (F-AAA) interest and principal is very strong.
This rating indicates that the degree of safety, timely payment of interest and
FAA- High
principal is strong. However, the relative degree of safety is not high as for
safety (F-AA)
fixed deposits with "FAAA" rating.
This rating indicates that the degree of safety regarding timely payment of
FA - Adequate
interest and principal is satisfactory. Changes in circumstances can
safety
affect such issues more than those in higher rated categories.
This rating indicates inadequate safety of timely payment of interest and
FB -Inadequate principal. Such issues are less susceptible to default than fixed deposits rated
safety below this category, but the uncertainties that the issuer faces would lead to
inadequate capacity to make timely interest and principal payments.
This rating indicates that the degree of safety regarding timely payment of
interest and principal is doubtful. Such issues have factors at present that
FC - High Risk
make them vulnerable to default. Adverse business or economic conditions
would lead to lack of ability or willingness to pay interest or principal.
This rating indicates that the issue is either in default or is expected to be in
FD - Default
default upon maturity.
CRISIL may apply '+' (plus') or '-' (minus) signs for rating from "FAA' to "FC" to indicate the
relative position within the rating category of the company raising Fixed Deposits.
Commercial
Paper:
This rating indicates that the degree of safety regarding timely payment on
p-1
the instrument is very strong.
This rating indicates that the degree of safety regarding timely payment on
P–2 the instrument is strong. However, the relative degree of safety is lower than
that for instruments rated "P-1".
This rating indicates that the -degree of safety regarding timely payment on
the instrument is adequate; however, the instrument is more vulnerable to the
P–3
adverse effects of changing circumstances than an instrument rated in the
two higher categories.
This rating indicates that the degree of safety regarding timely payment on
P-4 the instrument is minimal and it is likely to be adversely affected by short-
term adversities or less favourable conditions.
This rating indicates that the instrument is expected to be in default on
p-5
maturity or is in default.
CRISIL may apply '+' (plus) sign for ratings from 'P- I' to 'P-3' to reflect a comparatively high
standing within the category.

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 Appendix 2
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Discriminant Analysis Technique

The discriminant analysis technique is used in those cases where
items have to be classified into one of two populations on the
basis of one or more criteria. Examples of situations where the
discriminant analysis can be used are,
1. Classification of customer accounts into two classes, such as
good or bad on the basis of criteria such as current ratio and
return on investment of the customers’ business.
2. Classification of companies into two classes such as sick and
non-sick on the basis of criteria, such as profitability ratios,
leverage ratios and cash flow coverage ratio.
3. Classification of students into two categories such as likely
to pass an engineering course and not likely to pass the
engineering course on the basis of intelligence tests,
aptitude tests etc.
In each of the examples given above a discriminant function
must be established which can be used to classify. the customer
accounts or companies or students into the two classes.
Further, the cutoff point for the discriminant function must be
established in such a way that the probability of wrong
classification is minimised. The cutoff point may be visualised
as under

For choosing the cutoff point for the discriminant function, the
steps are as follows:
1. The Zi value for all observations as delivered from the
discriminant function must be determined and arranged in
an ascending order.
2. Identify where the observations from two groups overlap
and consider the midpoints of adjacently ranked
In the above figure though the distributions overlap and there observations as possible cutoff scores.
are chances of misclassifications, at the cutoff value represented 3. Choose that cutoff score for which the number of
by the point Z*, it can be seen that the misclassification is misclassifications are minimized.
minimised.
The discriminant analysis makes the following assumptions:
1. There are two discrete groups
2. Two selected variables would be combined in a linear
relationship and the linear function of the form, Zi = aXi +
bYi would be used for discriminating between the two
discrete groups
3. The two selected variables arise from multivariate normal
populations. Though the means of the two variables in
each group would be different, the variance/covariance
matrix is the same for each group.
The discriminant function of the form Zi = aXi + bYi can be
be obtained by maximising the ratio given below:

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302 11.671.3
 Venture Capital
UNIT 18 VENTURE CAPITAL
Objectives
After studying this unit, you should be able to understand:
l meaning and chief characteristics of Venture Capital;
l modus operandi of Venture Capital Funds, i.e.
l Stages of financing
l Modes of financing
l Exit routes
l regulatory framework for Venture Capital Funds in India and the tax
concessions granted to them; and
l venture Capital Funds in India.

Structure
18.1 Introduction
18.2 Distinguishing Features
18.3 Stages of Venture Capital Financing
18.4 Modes of Financing
18.5 Exit Routes
18.6 Regulatory Framework
18.7 SEBI Foreign Venture Capital Investors Regulations, 2000
18.8 Tax Exemptions
18.9 Venture Capital Funds in lndia
18.10 Summary
18.11 Self Assessment Questions
18.12 Further Readings

18.1 INTRODUCTION
One of the essential pre-requisites for the setting up of an industrial enterprise is
timely and adequate availability of finance. This problem becomes more acute when
an entrepreneur is a new and unknown technocrat, who possesses innovative ideas to
develop a new product, but lacks his own capital which is essential to turn his ideas
into a successful commercial venture. Finance required for such purpose is more
risky in nature, because the innovative ideas of the entrepreneur have not been tried
on a commercial scale. On the other hand, if the venture proves successful, it has
potential for high returns. Usual sources of finance cannot be tapped by the
entrepreneurs for lack of availability of funds from his own sources. In such
circumstances Venture Capitalist comes to his rescue by providing risk bearing
capital, which is widely known as Venture Capital.
Venture Capital may be broadly defined as long-term investment in business, which
has potential for significant growth and financial returns. This is usually provided in
the form of equity apart from conditional loans and conventional loans. Venture
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Fund Based Services Capitalists is thus not a financier only, but bears the risk as well. His return from the
enterprise depends upon the extent of the success achieved by it.
The most distinguishing feature of Venture Capital is that it meets the needs of a
business wherein the probability of loss is quite high because of the uncertainties
associated with the enterprise, but the returns expected are also higher than normal.
The entrepreneur intends to enter into an untrodden field. Thus, the Venture Capitalist
invests in a business where uncertainties have yet to be quantified into risks. Venture
Capital is thus termed as high risk, high return capital.

18.2 DISTINGUISHING FEATURES

Venture Capital can be distinguished from other forms of finance on the basis of its
special characteristics which are as follows:
1 ) The most distinguishing feature of Venture Capital is that it is provided largely in
the form of equity, when the investee company is unable to float its equity shares
independently in the market, or from other sources in the initial stage. Thus risk
capital is provided, which is not available otherwise due to the high degree of
risk involved in the venture.
2) The venture capitalist, though participates in the equity, does not intend to act as
the owner of the enterprise. The venture capitalist does not participate in the
day-to-day management, but aids and guides the management by providing the
benefit of his skill, experience and expertise. He nurtures the new enterprise till
it enters the profit-earning stage.
3) The Venture Capitalist does not intend to retain his investment in the investee
company for ever. He intends to divest his shares, as soon as the company
becomes a profitable business and the returns from the business are high as per
expectations. At this stage he withdraws himself from the venture and in turn
provides finance for another venture.
4) A Venture Capitalist intends to earn largely by way of capital gains arising out of
sale of his equity holdings, rather than through regular returns in the form of
interest on loans.
5) A Venture Capitalist also provides conditional loans which entitles him to earn
royalties on sales depending upon the expected profitability of the business.
(Such loan is partly or fully waived if the business enterprise does not prove to
be a success).

18.3 STAGES OF VENTURE CAPITAL FINANCING

A venture capital fund provides finance to the venture capital undertaking at different
stages of its life cycle according to requirements. These stages are broadly classified
into two, viz. (i) Early stage financing, and (ii) Later stage financing. Each of them is
further sub-divided into a number of stages. We shall deal with them individually.
Early Stage Financing includes: (i) Seed capital stage, (ii) Start-up stage, and
(iii) Second round financing.
i) Seed Capital Stage: This is the primary stage associated with research and
development. The concept, idea, process pertaining to high technology or
innovation are tested on a laboratory scale. Generally, the ideas developed by
Research and Development wings of companies or scientific research
institutions are tried. Based on laboratory trial, a prototype product development
is carried out. Subsequently, possibilities of commercial production of the product
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 is explored. The risk perception of investment at this stage if quite high and only Venture Capital
a few venture capital funds invest in the seed capital stage of product
development. Such financing is provided to the innovator in the form of low
interest bearing personal loans.
ii) Start-up Stage: Venture capital finance is made available at the start-up stage
of the projects which have been selected for commercial production. A start-up
refers to launching or beginning a new activity which may be the one taken out
from the Research and Development stage of a company or a laboratory or may
be based on transfer of technology from abroad. Such product may be an import
substitute or a new product/service which is yet to be tried. But the product
must have effective demand and command potential market in the country. The
entrepreneurs who lack financial resources for undertaking production, approach
the venture capital funds for extending funds through equity.
Before making such investments, venture capital fund companies assess the
managerial ability, capacity and the commitment of entrepreneur to make the
project idea as success. If necessary, the venture capital funds lend managerial
skills, experience, competence and supervise the implementation to achieve
successful operation. High degree of risk is involved in start-up financing.
iii) Second Round Financing: After the product has been launched in the market,
further funds are needed because the business has not yet become profitable
and hence new investors are difficult to attract. Venture capital funds provide
finance at such stage, which is comparatively less risky than the first two stages.
At this stage, finance is provided in the form of debt also, on which they earn a
regular income.
Later Stage Financing: Even when the business of the entrepreneur is established it
requires additional finance, which cannot be secured by offering shares by way of the
public issue. Venture capital funds prefer later stage financing as they anticipate
income at a shorter duration and capital gains subsequently. Later stage financing
may take the following forms:
i) Expansion Finance: Expansion finance may be needed by an enterprise for
adding production capacity once it has successfully gained market share and
expects growth in demand for its product. Expansion of an enterprise may take
the form of an organic growth or by way of acquisition or takeover. In the case
of organic growth the entrepreneur retains maximum equity holdings of the
entrepreneur and the venture capitalist could be in much higher proportion
depending upon factors such as the net worth of the acquired business, its
purchase price and the amount already raised by the company from the venture
capitalists.
ii) Replacement Finance: In this form of financing, the venture capitalist
purchases the shares from the existing shareholders of the company who are
willing to exit from the company. Such a course is often adopted with the
investors who want to exit from the investee company, and the promoters do not
intend to list its shares in the secondary market, the venture capitalist perceives
growth of the company over 3 to 5 years and expects to earn capital gain at a
much shorter duration.
iii) Turn Around: When a company is operating at a loss after crossing the early
stage and entering into commercial production, it may plan to bring about a
change in its operations by modernising or expanding its operations, by addition
to its existing products or deletion of the loss-making products, by reorganising
its staff or undertaking aggressive marketing of its products, etc. For undertaking
the above steps for reviving the company, infusion of additional capital is needed.
The funds provided by the venture capitalist for this purpose are called turn
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Fund Based Services around financing. In most of the cases, the venture capitalist which supported
the project at an early stage may provide turnaround finance, as a new venture
capitalist may not be interested to invest his funds at this stage.
Turn around financing is more risky proposition. Hence the venture capitalist has
to judge in greater depths the prospects of the enterprise to become viable and
profitable. Generally substantial investment is required for this form of financing.
Besides providing finance, the venture capitalist also provides management
support to the entrepreneur by nominating its own directors on the Board of the
company to effectively monitor the progress of recovery of the company and to
ensure timely’ implementation of the necessary measures.
iv) Buyout Deals: A venture capitalist may also provide finance for buyout deals.
A management buyout means that the shares (and management) of one set of
shareholders, who are passive shareholders, are purchased by another set of
shareholders who are actively involved in the operations of the organisation. The
latter group of shareholders buyout the shares from the inactive shareholders so
that they derive the full benefit from the efforts made by them towards
managing the enterprise. Such shareholders may need funds for buying the
shares, venture capitalist provide them with such funds. This form of financing is
called buyout financing.

18.4 MODES OF FINANCING

The venture capital funds provide finance to venture capital undertakings through
different modes/instruments which are traditionally divided into: (i) equity, and (ii) debt
instruments. Investment is also made partly by way of equity and partly as debt. The
VCFs select the instrument of finance taking into account the stage of financing, the
degree of risk involved and the nature of finance required. These instruments are
detailed below:
a) Equity Instruments: Equity instruments are ownership instruments and bestow
the rights of the owner on the investor/VCFs. They are:
i) Ordinary Shares on which no dividend is assured. Non-voting equity shares
may also be issued, which carry a little higher dividend, but no voting rights are
enjoyed by the investors. There may be different variants of equity shares also,
e.g. deferred equity shares on which the ordinary shares rights are deferred till a
certain period or happening of an event. Moreover, preferred ordinary shares
carry an additional fixed income.
ii) Preference Shares carry an assured dividend at a specified rate. Preference
shares may be cumulative/non-cumulative, participating preference shares which
provide for an additional dividend, after payment of dividend to equity
shareholders. Convertible preference shares are exchangeable with the equity
shares after a specified period of time.
Thus, the venture capital fund can select the instrument with fIexibility.
b) Debt Instruments: VCFs prefer debt instruments to ensure a return in the earlier
years of financing when the equity shares do not give any return. The debt
instruments are of various types, as explained below:
i) Conditional Loans: On conditional loans, no interest rate as lower rate of
interest and no payment period is prescribed. The VC funds, recover their funds,
along with the return thereon by way of a share in the sales of the undertaking
for a specified period of time. This percentage is pre-determined by VCFs. The
recovery by the VCFs depends upon the success of the business enterprise.
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ii) Convertible Loans: Sometimes loans are provided with the stipulation that they Venture Capital
may be converted into equity at a later stage at the option of the lender or as
agreed upon between the two parties.
iii) Conventional Loans: These loans are the usual term loans carrying a specified
rate of interest and are repayable in instalments over a number of years.

18.5 EXIT ROUTES

The venture capital company/fund after financing a venture capital undertaking
nurtures it to make it a successful proposition, but it does not intent to retain its
investment therein forever. As the venture capital undertaking starts its commercial
operations and reaches the profit-earning stage, the venture capitalist endeavours to
disinvest its investments in the company at the earliest. The primary aim of the
venture capitalist happens to realize appreciation in the value of the shares held by
him and thereafter to finance another venture capital undertaking. This is called the
exit route. There are several alternatives before venture capitalist to exit from an
investee company, as stated below:
i) Initial Public Offering: When the shares of the investee company are listed on
the stock exchange(s) and are quoted at a premium, the venture capitalist offers
his holdings for public sale through public issue.
ii) Buy back of Shares by the Promoters: In terms of the agreement entered
into with the investee company, promoters of the company are given the first
opportunity to buy back the shares held by the venture capitalist, at the prevailing
market price. In case they refuse to do so, other alternatives are resorted to by
the venture capitalist.
iii) Sale of Enterprise to another Company: Venture capitalist can recover his
investments in the investee company by selling the holdings to outsider who is
interested in buying the entire enterprise from the entrepreneur.
iv) Sale to New Venture Capitalist: A venture capitalist can sell his equity
holdings in the enterprise to a new venture capital company, who might be
interested in buying the ownership portion of the venture capital. Such sale may
be distress sale by the venture capitalist to realise the investments and exit from
the enterprise. Alternatively, such sale may be for inducting a willing venture
capitalist who wishes to take the existing liability in the company to provide
second round of funding.
v) Self-liquidating Process: In case of debt financing by the venture capitalist,
the process is self-liquidating in nature, as the principal amount, along with
interest is realised in instalments over a specified period of time.
vi) Liquidation of the Investee Company: If the investee company does not
become profitable and successful and incurs losses, the venture capitalist resorts
to recover his investment by negotiation or settlement with the entrepreneur.
Failing which the recovery is resorted to by means of winding up of the
enterprise through the court.

Activity 1
1) List out the characteristics of Venture Capital.
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Fund Based Services 2) List out the various forms of early stage financing.
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18.6 REGULATORY FRAMEWORK

The venture capital funds and venture capital companies in India were regulated by
the Guidelines issued by the Controller of Capital Issues, Government of India, in
1988. In 1995, Securities and Exchange Board of India Act was amended which
empowered SEBI to register and regulate the Venture Capital Funds in India.
Subsequently, in December, 1996 SEBI issued its regulations in this regard. These
regulation replaced the Government Guidelines issued earlier. The SEBI guidelines, as
amended in 2000, are as follows:

1) Definitions
A Venture Capital Fund has been defined to mean a fund established in the form of a
trust or a company including a body corporate and registered with SEBI which –
i) has a dedicated pool of capital, raised in the specified manner, and
ii) invests in venture capital undertakings in accordance with these regulations.
A Venture Capital Fund may be set up either as a trust or as a company. The purpose
of raising funds should be to invest in Venture Capital Undertakings in the specified
manner.
A Venture Capital Undertaking means a domestic company –
i) whose shares are not listed on a recognised stock exchange in India, and
ii) which is engaged in the business for providing services, production or
manufacture of articles or things and does not include such activities or sectors
which have been included in the negative list by the Board.
The negative list of activities includes real estate, non-banking financial services, gold
financing, activities not permitted under Government’s Industrial Policy and any other
activity specified by the Board.
2) Registration of Venture Capital Funds
A venture capital fund may be set up either by a company or by a trust. SEBI is
empowered to grant a certification of registration to the fund on an application made
to it. The applicant company or trust must fulfil the following conditions:
i) The memorandum of association of the company must specify, as its main
objective, the carrying of the activity of a venture capital fund.
ii) It is prohibited by its memorandum of association and Articles of Association
from making an invitation to the public to subscribe to its securities.
iii) Its director, or principal officer or employee is not involved in any litigation
connected with the securities market.
iv) Its director, principal officer or employee has not been at any time convicted of
an offence involving moral turpitude or any economic offence.
v) The applicant is a fit and proper person.

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In case an application has been made by a Trust, the instrument of Trust must be in Venture Capital
the form of a Deed and the same must have been duly registered under the Indian
Registration Act, 1908. It must also comply with the above-mentioned conditions
(ii) to (v).
On receipt of the Certificate of Registration, it shall be binding on the venture capital
fund to abide by the provisions of SEBI Act and these Regulations. Venture Capital
Fund shall not carry on any other activity than that of a Venture Capital Fund.

3) Resources for Venture Capital Fund

A Venture Capital Fund may raise moneys from any investor – India, foreign or non
Resident Indian – by way of issue of units, povided the minimum amount accepted
from an investor is Rs. 5 lakh. This restriction does not apply to the employees,
principal officer or directors of the venture capital fund, or non-Resident Indians or
persons or institutions of Indian Origin. It is essential that the venture capital fund
shall not issue any document or advertisement inviting offers from the public for
subscription to its securities/units.
Moreover, each scheme launched or fund set up by a venture capital fund shall have
firm commitment from the investors to contribute at least Rs. 5 crore before the start
of its operations.

4) Investment Restrictions
While making investments, the venture capital fund shall be subject to the following
conditions:
a) A Venture Capital Fund shall disclose the investment strategy at the time of
application for registration.
b) A Venture Capital Fund shall not invest more than 25% of its corpus in one
venture capital undertaking.
c) It shall not invest in the associated companies.
d) It shall make investment in the venture capital undertakings as follows:
i) at least 75% of the investible funds shall be invested in unlisted equity shares
or equity-linked instruments (i.e., instruments convertible into equity shares
or share warrants, preference shares, debentures compulsorily convertible
into equity),
ii) not more than 25% of the investible funds may be invested by way of
a) subscription to initial public offer of a venture capital undertaking whose
shares are proposed to be listed, subject to a lock in period of one year.
b) debt or debt instruments of a venture capital undertaking in which the
venture capital fund has already made investment by way of equity.

5) Prohibition on Listing
The securities or units issued by a venture capital fund shall not be entitled to be listed
on any recognised stock exchange till the expiry of 3 years from the date of issuance
of such securities or units.

6) Private Placement of Securities/Units

A venture capital fund may receive moneys for investment in the venture capital
undertakings only through private placement of its securities/units. For this purpose
the venture capital fund/company shall issue a placement memorandum which shall
contain details of the terms subject to which moneys are proposed to be raised.
Alternatively, it shall enter into contribution or subscription agreement with the
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Fund Based Services The venture capital fund shall also file with SEBI a copy of the above memorandum/
agreement together with a report on money actually collected from the investors.

7) Winding up of Venture Capital Fund Scheme

A Scheme of a Venture Capital Fund set up as a Trust shall be wound up, in any of
the following circumstances, namely:
i) when the period of the scheme, if any is over or
ii) if the trustees are of the opinion that the winding up shall be in the interest of the
investors, or
iii) 75% of the investors in the scheme pass a resolution for the winding up, or
iv) SEBI so directs in the interest of investors.
A Venture Capital Company shall be wound up in accordance with the provisions of
the Companies Act.

8) Powers of the Securities and Exchange Board of India

SEBI has the following powers:
a) to appoint inspecting/investigating officers to undertake inspection/investigation
of the books of accounts, records and documents of Venture Capital Fund.
b) to suspend the certificate granted to a Venture Capital Fund if it contravenes any
provisions of the SEBI Act or these guidelines or fails or defaults in submitting
any information as required by SEBI or submits false/misleading information,
etc.
c) to cancel the certificate in the following cases:
i) Venture capital fund is guilty of fraud or has been convicted of an offence
involving moral turpitude.
ii) Venture capital fund has been guilty of repeated defaults mentioned in (b)
above.
iii) Venture capital fund contravenes any of the provisions of the Act or the
Regulations.

18.7 SEBI FOREIGN VENTURE CAPITAL INVESTORS

REGULATIONS, 2000
Investments in Venture Capital Funds or Venture Capital Undertakings in India can
also be made by foreign venture capital investors, incorporated outside India. To
regulate such investors, SEBI issued the above mentioned Regulations in the year
2000. The salient features of these regulations are as follows:

Registration
A foreign venture capital investor (FVCI) must be registered with SEBI after fulfilling
the following eligibility conditions and on payment of application fee of US $1000:
1) Its track record, professional competence, financial soundness, experience,
reputation of fairness and integrity.
2) RBI has granted approval of investing in India
3) It is an investment company, trust, partnership, pension or mutual or endowment
fund, charitable institution or any other entity incorporated outside India.
4) It is an asset/investment management company, investment manager or any
60 other investment vehicle incorporated outside India.
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5) It is authorised to invest in Venture Capital Fund or to carry on activity as Venture Capital
Venture Capital Fund.
6) It is regulated by an appropriate foreign regulatory authority or is an income tax
payer. Otherwise, it submits a certificate from its bankers about its promoters’
track record.
7) It is a fit and proper person.
SEBI will grant the Certificate of Registration on receipt of the registration fee of
US $10,000 on the following conditions:
a) it would appoint a domestic custodian for the custody of securities.
b) to enter into an agreement with any bank to act as its banker for operating a
special non-resident rupee/foreign currency account.

Investment Criteria
FVCls must disclose their investment strategy to SEBI. They are permitted to invest
their total funds committed in one venture capital funds, but for investing in venture
capital undertakings they have to follow the norms as prescribed by SEBI domestic
VCFs.

Powers of SEBI
SEBI has the following powers as regards FVCls:
i) Power to conduct inspection/investigation in respect of conduct and affairs of
FVCls.
ii) Power to issue directions in the interest of the capital market and investors.
iii) Power to suspend or cancel registration.
iv) Power to call for any information.

18.8 TAX EXEMPTIONS

Clause 23F was inserted in Section 10 of the Income Tax Act in the year 1995 to
exempt income by way of dividends or long term capital gains of a venture capital
fund/company, derived from investments in equity shares of venture capital
undertakings, subject to fulfilment of certain conditions.
Since the financial year 2000-01 under clause 23FB the entire income of venture
capital funds has been granted exemption from taxation as these incomes merely pass
through the dividends to investors. Hence, from the assessment year 2001-02 any
income of venture capital fund/company has been exempted. Such exemption’
continues even after the shares of venture capital undertaking are listed on a
rccognised stock exchange. Income distributed by the venture capital funds will be
taxed in the hands of the investors at rates applicable to them.
Services sector has also been included under the venture capital functions.

18.9 VENTURE CAPITAL FUNDS IN INDIA

Venture capital funds are comparatively of recent origin in India. As new
technological developments and growth of entrepreneurship have started in India
during the last two/three decades, a number of venture capital funds have been set up
in India. These funds have been promoted by institutions at the national and state
levels, banks and private sector individuals, as shown in the following chart
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Fund Based Services Venture Capital Funds in India

Promoted by

All India Financial State level Commercial Private Sector

Institutions Financial Institutions Banks Institutions

Indian Foreign

IFCI Venture IDBI Venture ICICI Venture SIDBI Venture

Capital Funds Ltd. Capital Fund Funds Management Capital Ltd.
Company Ltd.

In 2003 there were 43 domestic venture capital funds and 6 foreign capital funds
registered with SEBI.
Amongst the Commercial Banks, ANZ Grindlays Bank set up the first private sector
venture capital fund, namely; India Investment Fund with an initial capital of Rs. 10
crore subscribed by Non-Resident Indians. Amongst the Indian banks, the
subsidiaries of State Bank of India and Canara Bank have floated venture capital
funds.
Gujarat Venture Capital Finance Ltd., set up by Gujarat Industrial and Investment
Corporation Ltd. in association with the World Bank, is a pioneer venture capital firm
in India. Its investors include the World Bank, Gujarat Industrial and Investment
Corporation, Industrial Development Bank of India, CDC (UK) SIDBI and other
private and public sector organisations. Currently, it is managing four funds.
IL&FS Vcnture Corporation Ltd. is a fund management company. It is a
subsidiary of Infrastructure Leasing and Financial Services Ltd. set up jointly with
Bank of India and multilateral development agencies. It was earlier known as Credit
Capital Venture Fund (India) Ltd. At present the company is managing 7 domestic
venture capital funds.
IFB Venture Capital Finance Ltd: This company has been promoted by IFB
Industries Ltd. jointly with IDBI and ICICI.
IFCI Venture Capital Funds Ltd. (IVCF): In 1975, the IFCI Ltd. established
‘Risk Capital Foundation’ as a society to provide risk capital assistance in the form of
soft loans to professionals and technocrats setting up their own industrial ventures. In
1988, this society was converted into a company named Risk Capital and Technology
Finance Corporation Ltd. primarily to provide direct equity to the companies (instead
of providing soft loans to promoters). It introduced Technology Finance and
Development Scheme in 1988 to provide finance for improvement of technology.
Subsequently, it took up the management of a venture fund to provide finance for
innovative projects. The earlier two schemes were discontinued and its entire focus
was laid on management of venture capital. The company is now known as IFCI
Venture Capital Funds Ltd.

Venture Capital Fund of IDBI

lDBI has constituted a Venture Capital Fund with the objective to encourage
commercial application of indigenous technologies or adoption of imported
technologies, development of innovative products and services, holding substantial
potential for growth and bankable ventures involving higher risk including those in the
Information Technology sector.
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All industrial concerns are eligible under the scheme. The main criteria for granting Venture Capital
assistance is high growth prospects, potential for capital appreciation and clear-cut
exit route within 3 to 5 years. IDBI excludes mature industries, commodity-type
products and highly competitive sectors.
Assistance is provided in the form of equity, term loans and convertible debt with
ceiling of 80% of the project cost. lDBI’s exposure is restricted to Rs. 20 crore in
each venture, though there is no upper limit on the cost of the venture. Promoter’s
contribution should be 20% of the cost of the project. Repayment period may be
upto 5 years after initial moratorium of one to one and a half year IDBI charges
up-front fee @1.05% of term loan and a front-end fee @2.6% on direct subscription
to equity.
IDBI secures its assistance by first mortgage/charge on the fixed assets and by
personal guarantees from promoters or by way of pledge of shares by promoters.
The venture capital fund of lDBI stood at Rs. 179 crore as on March 31, 2003.

ICICI Venture Funds Management Company Ltd.

This company is a wholly owned subsidiary of ICICI Bank Ltd. It provides assistance
to small and medium industries promoted by technocrat entrepreneurs in the form of:
(i) project loans, (ii) direct subscription to equity, and (iii) conditional loans.
The company provides venture capital assistance to a wide spectrum of industrial
sectors. It extends assistance primarily through the venture funds and Private Equity
Funds managed/advised by it. As on March 31, 2001 the company managed/advised
eleven funds with an aggregate corpus of Rs. 9.06 billion with an investment focus
both in Indian and global companies.
As the manager of these funds, the company is entitled to annual management fee
and a performance fee which depends on the payouts to the fund investors. The
accounts of these funds are maintained separately and do not form part of the
company’s accounts. In respect of private equity funds advised by the company it is
entitled to an advisory fee. All fees are recognised as revenue of the company on
accrual basis. Venture funding does not form part ofthe company’s business on its
own account, but out ofthe funds managed by it.
This company retains its position as the most significant institution in the Indian
Private Equity Industry. It was one of the earliest to recognise the value of investing
in knowledge based sectors like information technology and bio-technology. As at the
end of March 2004 its paid up Capital was Rs. 31.3 million, Reserves Rs. 381 million
and total assets Rs. 530.8 million and total liabilities Rs. 118.5 million.

SIDBI Venture Capital Limited

SIDBI Venture Capital Ltd. is a subsidiary of Small Industries Development Bank of
India (SIDBI), which was established to carryout the business of setting up and
managing venture capital funds in the small scale sector. This company has been
acting as the Investment Manager to National Venture Fund for Software and
Information Technology Industry (NFSIT). SIDBI Trustee Company Ltd., another
subsidiary of SIDBI acts as Trustee company for the Fund.
NFSIT is a 10 year close-ended venture capital fund with a committed corpus of
Rs. 100 crore. This fund has been contributed by SIDBI, lDBI and Ministry of
Communications and Information Technology, Government of India. Investments by
the Fund include Info-tech sector, software industry and related businesses, such as
networking, multimedia, data communication, value-added telecommunication services
and/or any other related sectors.
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Fund Based Services The Fund has raised an amount of Rs. 66.67 crore till 2002-03 from the contributors
out of a committed corpus of Rs. 100 crore. Its cumulative sanctions aggregated
Rs. 54.89 crore to 24 companies and cumulative disbursements till 2002-03
aggregated Rs. 30.09 crore to 17 companies. Slow growth in sanctions and
disbursements was due to cautious approach followed by the fund on account of
depressed market conditions. However, to spread risk, the company has created a
diversified portfolio to cover a wide area of IT industries.

18.10 SUMMARY
In this unit we have explained the meaning and distinguishing features of Venture
Capital. It has been rightly designated as “high risk, high reward” capital. Venture
Capital is provided to venture capital undertakings at different stages of their life
cycle, which have been duly explained. Venture capital takes the form of equity,
conventional loans, conditional loans and convertible loans. A venture capitalist divest
his investments in the investee company at the earliest possible opportunity.
There are several exit routes for him, which we have explained.
In India, Venture Capital Funds/Companies are of recent origin and are regulated by
Securities and Exchange Board of India (SEBI). SEBI has issued detailed regulations
for this purpose, which have been explained in detail. Similarly, SEBI has also issued
regulations for Foreign Venture Capital Investors. Incomes of Venture Capital Funds/
Companies have been granted exemption from taxation under the Income Tax Act. In
the end, the Venture Capital Funds/Companies established in India by all India
Financial Undertakings have been described. Besides, there are a number of venture
capital funds set up by other institutions and Indian and foreign investors.

18.11 SELF ASSESSMENT QUESTIONS

1) What do you understand by Venture Capital? Describe its distinguishing
features.
2) Explain the various stages at which the venture capitalist provide finance.
3) Distinguish between conditional loans and convertible loans and explain their
significance.
4) What do you understand by Exit Routes? Enumerate the important exit routes
and explain the important ones.
5) What are Investment Restrictions imposed by SEBI on venture capital funds in
India.
6) Explain the provision of Income Tax Act, granting tax concessions to venture
capital funds in India.

18.12 FURTHER READINGS

Bhole, L.M. Financial Institutions and Markets, 4th ed. 2004, Tata McGraw Hill
Publishing Co. Ltd.
Khan, M.Y. Financial Services, 3rd ed. 2004, Tata McGraw Hill Publishing Co. Ltd.
Rustagi, R.P. Financial Analysis and Financial Management, 2005 ed., Sultan
Chand & Sons.
Varshney, P.N. and Mittal, O.K. Indian Financial System, 6th ed. 2005, Sultan
Chand & Sons.
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CROWDFUNDING
Ms P Deepika
Department of commerce
Kathir College of Arts and Science
Coimbatore-62

ABSTRACT
Crowdfunding is getting a lot of press lately and it should. It's turning into an accepted process
to raise money for an idea, product, or entire business. Entrepreneurs now have crowdfunding
as a finance option when they're thinking about financing their business. Crowdfunding can be
a complement or substitute for traditional forms of financing, like angel investing, venture
capital, and bank loans.

But with different flavors of crowdfunding to choose from, which is the right one for an
entrepreneur to choose. That's the subject we'll explore in this article.

It’s important to understand that there are various kinds of crowdfunding and each comes with
its own strengths. We'll look at each type of crowdfunding, define how it works, and see if it's a
good match for your business.
Key words -Entrepreneurs Equity Debt-based Litigation.

INTRODUCTION:
Crowdfunding is the practice of funding a project or venture by raising small amounts of money
from a large number of people, typically via the Internet. Crowdfunding is a form
of crowdsourcing and alternative finance. In 2015, over US$34 billion was raised worldwide by
crowdfunding. Although similar concepts can also be executed through mail-order
subscriptions, benefit events, and other methods, the term crowdfunding refers to Internet-
mediated registries. This modern crowdfunding model is generally based on three types of
actors: the project initiator who proposes the idea or project to be funded, individuals or groups

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who support the idea, and a moderating organization (the "platform") that brings the parties
together to launch the idea.
Crowdfunding has been used to fund a wide range of for-profit, entrepreneurial ventures such as
artistic and creative projects, medical expenses, travel, and community-oriented social
entrepreneurship projects. Its use has also been criticised for funding quackery, especially costly
and fraudulent cancer treatments. Crowdfunding has a long history with several roots. Books
have been crowdfunded for centuries: authors and publishers would advertise book projects in
praenumeration or subscription schemes. The book would be written and published if enough
subscribers signaled their readiness to buy the book once it was out. The subscription business
model is not exactly crowdfunding, since the actual flow of money only begins with the arrival
of the product. The list of subscribers has, though, the power to create the necessary confidence
among investors that is needed to risk the publication.
War bonds are theoretically a form of crowdfunding military conflicts. London's mercantile
community saved the Bank of England in the 1730s when customers demanded their pounds to
be converted into gold - they supported the currency until confidence in the pound was restored,
thus crowdfunded their own money. A clearer case of modern crowdfunding is Auguste
Comte's scheme to issue notes for the public support of his further work as a philosopher. The
"Première CirculaireAnnuelleadressée par l'auteur du Système de Philosophie Positive" was
published on 14 March 1850, and several of these notes, blank and with sums have survived.
The cooperative movement of the 19th and 20th centuries is a broader precursor. It generated
collective groups, such as community or interest-based groups, pooling subscribed funds to
develop new concepts, products, and means of distribution and production, particularly in rural
areas of Western Europe and North America. In 1885, when government sources failed to
provide funding to build a monumental base for the Statue of Liberty, a newspaper-led
campaign attracted small donations from 160,000 donors.
Crowdfunding on the internet first gained popular and mainstream use in the arts and music
communities. The first noteworthy instance of online crowdfunding in the music industry was
in 1997, when fans underwrote an entire U.S. tour for the British rock band Marillion, raising
US$60,000 in donations by means of a fan-based Internet campaign. They subsequently used
this method to fund their studio albums.

This built on the success of crowdfunding via magazines, such as the 1992 campaign by the
Vegan Society that crowdfunded the production of the "Truth or Dairy" video documentary. In
the film industry, independent writerdirector Mark TapioKines designed a website in 1997 for
his then-unfinished first feature film Foreign Correspondents. By early 1999, he had raised
more than US$125,000 on the Internet from at least 25 fans, providing him with the funds to
complete his film. In 2002, the "Free Blender" campaign was an early software crowdfunding
precursor. The campaign aimed for open-sourcing the Blender 3D computer graphics software
by collecting €100,000 from the community while offering additional benefits for donating
members.

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The first company to engage in this business model was the U.S. website ArtistShare (2001). As
the model matured, more crowdfunding sites started to appear on the web such as Kiva (2005),
IndieGoGo (2008), Kickstarter (2009), GoFundMe (2010), Microventures (2010), and
YouCaring (2011).
The phenomenon of crowdfunding is older than the term "crowdfunding". According to
wordspy.com, the earliest recorded use of the word was in August 2006.

TYPES
The Crowdfunding Centre's May 2014 report identified two primary types of crowdfunding:

Rewards crowdfunding:
Entrepreneurs presell a product or service to launch a business concept without incurring debt
or sacrificing equityshares.Equity crowdfunding: the backer receives shares of a company,
usually in its early stages, in exchange for the money pledged.Reward-based crowdfunding has
been used for a wide range of purposes, including motion picture promotion, free software
development, inventions development, scientific research,and civic projects.Many
characteristics of rewards-based crowdfunding, also called non-equity crowdfunding, have been
identified by research studies. In rewards-based crowdfunding, funding does not rely on
location. The distance between creators and investors on Sellaband was about 3,000 miles when
the platform introduced royalty sharing. The funding for these projects is distributed unevenly,
with a few projects accounting for the majority of overall funding. Additionally, funding
increases as a project nears its goal, encouraging what is called "herding behaviour". Research
also shows that friends and family account for a large, or even majority, portion of early
fundraising. This capital may encourage subsequent funders to invest in the project. While
funding does not depend on location, observation shows that funding is largely tied to the
locations of traditional financing options. In reward-based crowdfunding, funders are often too
hopeful about project returns and must revise expectations when returns are not met.

PLATFORMS:
In 2012, there were over 450 crowdfunding platforms operating.In 2015, it was predicted that
there would be over 2,000 crowdfunding sites to choose from in 2016.Fundamental differences
exist in the services provided by many crowdfunding platforms.For instance, CrowdCube and
Seedrs are Internet platforms which enable small companies to issue shares over the Internet
and receive small investments from registered users in return. While CrowdCube is meant for
users to invest small amounts and acquire shares directly in start-up companies, Seedrs pools
the funds to invest in new businesses, as a nominated agent.

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Curated crowdfunding platforms serve as "network orchestrators" by curating the offerings that
are allowed on the platform. They create the necessary organizational systems and conditions
for resource integration among other players to take place.Relational mediators act as an
intermediary between supply and demand. They replace traditional intermediaries (such as
traditional record companies, venture capitalists).
These platforms link new artists, designers, project initiators with committed supporters who
believe in the persons behind the projects strongly enough to provide monetary support.[citation
needed] Growth engines focus on the strong inclusion of investors. They "disintermediate" by
eliminating the activity of a service provider previously involved in the network.
The platforms that use crowdfunding to seek stakes from a community of high net-worth private
investors and match them directly with project initiators.[citation needed.

BENEFITS AND RISKS:

Benefits for the creator:
Crowdfunding campaigns provide producers with a number of benefits, beyond the strict
financial gains. The following are non financial benefits of crowdfunding.
Profile – A compelling project can raise a producer's profile and provide a boost to their
reputation.
Marketing – Project initiators can show there are an audience and market for their project. In
the case of an unsuccessful campaign, it provides good market feedback.
Audience engagement – Crowdfunding creates a forum where project initiators can engage
with their audiences. An audience can engage in the production process by the following
progress through updates from the creators and sharing feedback via comment features on the
project's crowdfunding page.
Feedback – Offering pre-release access to content or the opportunity to beta-test content to
project backers as a part of the funding incentives provides the project initiators with instant
access to good market testing feedback.
There are also financial benefits to the creator. For one, crowdfunding allows creators to attain
low-cost capital. Traditionally, a creator would need to look at "personal savings, home equity
loans, personal credit cards, friends and family members, angel investors, and venture
capitalists." With crowdfunding, creators can find funders from around the world, sell both their
product and equity, and benefit from increased information flow. Additionally, crowdfunding
that supports pre-buying allows creators to obtain early feedback on the product. Another
potential positive effect is the propensity of groups to "produce an accurate aggregate
prediction" about market outcomes as identified by author James Surowiecki in his book The
Wisdom of Crowds, thereby placing financial backing behind ventures likely to succeed.
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Proponents also identify a potential outcome of crowdfunding as an exponential increase in

available venture capital. One report claims that if every American family gave one percent of
their investable assets to crowdfunding, $300 billion (a 10X increase) would come into venture
capital. Proponents also cite that a benefit for companies receiving crowdfunding support is that
they retain control of their operations, as voting rights are not conveyed along with ownership
when crowdfunding. As part of his response to the Amanda Palmer Kickstarter controversy,
Albini expressed his supportive views of crowdfunding for musicians, explaining: "I've said
many times that I think they're part of the new way bands and their audience interact and they
can be a fantastic resource, enabling bands to do things essentially in cooperation with their
audience." Albini described the concept of crowdfunding as "pretty amazing."

RISKS AND BARRIERS FOR THE CREATOR:

Crowdfunding also comes with a number of potential risks or barriers. For the creator, as well
as the investor, studies show that crowdfunding contains "high levels of risk, uncertainty, and
information asymmetry."
Reputation – failure to meet campaign goals or to generate interest results in a public failure.
Reaching financial goals and successfully gathering substantial public support but being unable
to deliver on a project for some reason can severely negatively impact one's reputation.
IP protection – many Interactive Digital Media developers and content producers are reluctant
to publicly announce the details of a project before production due to concerns about idea theft
and protecting their IP from plagiarism. Creators who engage in crowdfunding are required to
release their product to the public in early stages of funding and development, exposing
themselves to the risk of copy by competitors.
Donor exhaustion – there is a risk that if the same network of supporters is reached out to
multiple times, that network will eventually cease to supply necessary support.

CONCLUSION:
In conclusion, there’s a lot to be won by including crowdfunding into organisations’ existing set
of fundraising tools, both for individual organisations as well as for the development sector as a
whole. Crowdfunding is already part and parcel to many organisations’ and individuals’ wish to
make the world a better place and helppeople around the globe to improve their lives. Its
obvious benefit is raising money. Crowdfunding is credited with overcoming financing barriers
to small grassroots projects that don‘t have access to banks and large donors.
But pioneers of crowdfunding discovered quite early that the concept is not at all about the
money and that “you can sometimes make much more than you ever intended, or asked for”, as
Scott Steinberg put it in his Crowdfunding Bible.

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Crowdfunding not only provides money to organisations, it also boosts their man power as the
crowd that funds them also puts their institutional structures on a broader footing. The
supporters unwittingly become an additional marketing team by promoting the project they
funded to their friends and networks.
Another side-product of crowdfunding therefor is testing the popularity and effectiveness of a
project with very little means, often before the project has even started. “An unexpected benefit
of crowdfunding campaigns is that you will often receive very useful advice – and even tangible
offers of assistance – from backers,who, after all, want you to succeed and will do everything
they can to help you get there,” said Dave Balzer in his interview with ikosom.
As an offshoot of crowdsourcing, which in turn has its roots in the open innovation movement,
crowdfunding follows an “open” approach that applies the open source principles developed in
the field of software development. Therefore it can significantly improve an organisation‘s
efficiency through open innovation processes. As crowdfunding opens up organisations and
exposes their projects to a large community of supporters who provide feedback and ideas, it
encourages organisations to rethink their own concepts off the beaten track of
developmentwork.Once an organisation has gained some experience in crowdfunding, it can
also branch out into crowdsourcing activities more easily, e.g. by integrating external resources
and concepts like E-Volunteering to support project work. Here, platforms like Volunteer
Forever enter the picture, as they enable to financially support volunteers for going and working
abroad.

REFERENCES:

1. https://www.crowdcrurx.com
2. https://articles.bplans.com
3. The Crowdfunding Bible.
4. The Kickstarter Launch Formula.

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 Consultation Paper on Crowdfunding in India

1.0 Introduction
1.1 This consultation paper aims to provide a brief overview of the global scenario of
crowdfunding including the various prevalent models under it, the associated benefits
and risks, the regulatory approaches in different jurisdictions etc. The paper also covers
the extant legal structure governing the fund raising for start ups and SMEs in India. The
paper discusses legal and regulatory challenges in implementing the framework for
Crowdfunding. This paper proposes framework for ushering in crowdfunding by giving
access to capital market to provide an additional channel of early stage funding to Start-
ups and SMEs and seeks to balance the same with investor protection. Through this
consultation paper SEBI intends to invite comments and suggestions from industry and
market participants regarding the different possible structures for crowdfunding within
the existing legal framework and other associated issues.

1.2 The Consultation Paper has been put forward for discussion only and does not
necessarily mean that a Crowdfunding Regulation would be introduced in the form as
proposed in the consultation paper or in any other form.

2.0 What is Crowdfunding?

2.1 Crowdfunding is solicitation of funds (small amount) from multiple investors through
a web-based platform or social networking site for a specific project, business venture
or social cause.

2.2 Crowd sourced funding is a means of raising money for a creative project (for
instance, music, film, book publication), a benevolent or public-interest cause (for
instance, a community based social or co-operative initiative) or a business venture,
through small financial contributions from persons who may number in the hundreds or

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thousands. Those contributions are sought through an online crowd-funding platform,
while the offer may also be promoted through social media. 1

3.0 Types of Crowd-Funding

3.1 As per IOSCO Staff Working Paper - Crowd-funding: An Infant Industry Growing
Fast, 2014 ('IOSCO Paper'), Crowd-funding can be divided into four categories:
donation crowdfunding, reward crowdfunding, peer-to-peer lending and equity
crowdfunding.

Crowdfunding

Social
Reward Peer-to-Peer Equity
Lending/Donation
Crowdfunding Lending Crowdfunding
Crowdfunding

Community Crowdfunding Financial Return Crowdfunding

Source: IOSCO Staff Working Paper - Crowd-funding: An Infant Industry Growing Fast , 2014

3.2 Donation Crowdfunding

3.2.1 Donation crowdfunding denotes solicitation of funds for social, artistic, philanthropic
or other purpose, and not in exchange for anything of tangible value.

3.2.2 For example, In the US, Kickstarter, Indiegogo etc. are some of the platforms that
support donation based crowdfunding.

1 Crowd Based Equity Funding – Discussion Paper - Corporations and Markets Advisory Committee, Australia, September , 2013

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3.3 Reward Crowdfunding
3.3.1 Reward crowdfunding refers to solicitation of funds, wherein investors receive
some existing or future tangible reward (such as an existing or future consumer product
or a membership rewards scheme) as consideration.

3.3.2 Most of the websites which support donation crowdfunding, also enable reward
crowdfunding, e.g. Kicktstarter, Rockethub etc.

3.4 Peer-to-Peer lending

3.4.1 In Peer-to-Peer lending, an online platform matches lenders/investors with
borrowers/issuers in order to provide unsecured loans and the interest rate is set by the
platform. Some Peer-to-Peer platforms arrange loans between individuals, while other
platforms pool funds which are then lent to small and medium-sized businesses.

3.4.2 Some of the leading examples from the US are Lending Club, Prosper etc. and
from UK are Zopa, Funding Circle etc.

3.4.3 A report by the Open Data Institute in July 2013 found that between October 2010
and May 2013 some 49,000 investors in the UK funded peer-to-peer loans worth more
2
than £378m.

3.4.4 Some of the platforms charge a fee based on the loan origination and have an
incentive to push investors into larger loans which may not suit an investor’s risk profile.

3.4.5 Though, Peer-to-peer lending did not appear to involve securities,

loan/notes/contracts can be traded on a peer-to-peer platform or a secondary market.
Thus, these loans may become securities, with the contract between the lender and the
3
borrower being the security note.

2 Crowd Based Equity Funding – Discussion Paper - Corporations and Markets Advisory Committee, Australia,
September , 2013
3 IOSCO Staff Working Paper - Crowd-funding: An Infant Industry Growing Fast , 2014

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3.4.6 In peer-to-peer lending, there is no investor protection by way of a compensation
scheme to cover defaults in this market as there is with deposit guarantee schemes for
bank deposits. Retail investors, who do not have the capacity to absorb defaults, may
lose significant proportions of their investments, if there are any defaults.

3.4.7 As per IOSCO paper, in some Jurisdiction like Germany and Italy, peer-to-peer
platforms are classified as banks (due to their credit intermediation function) and are
therefore regulated as banks.

3.5 Equity Based Crowdfunding

3.5.1 In Equity Based Crowdfunding, in consideration of funds solicited from investors,
Equity Shares of the Company are issued.

3.5.2 It refers to fund raising by a business, particularly early-stage funding, through

offering equity interests in the business to investors online. Businesses seeking to raise
capital through this mode typically advertise online through a crowdfunding platform
website, which serves as an intermediary between investors and the start-up
companies.

3.5.3 Traditionally, Start-ups are funded through private equity, angel investor or loan
arrangements with a financial institution. Any offering of public equity takes place only
after the product or business becomes commercially viable. However, in Equity based
Crowdfunding solicitation is done at an earlier stage.

Some examples of equity crowdfunding platforms are Syndicate Room, Crowdcube and
Seedrs.

3.5.4 In a few jurisdictions (like China), these platforms are restricted to offer this type
of capital raising to sophisticated investors or to a limited number of individual investors.
In China, an equity raising offer made to less than 200 individuals does not need to fulfil
the public equity raising requirements.
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4.0 Benefits of Crowdfunding
i. Crowdfunding provides a much needed new mode of financing for start-ups and
SME sector and increases flows of credit to SMEs and other users in the real
economy.
ii. Financial crisis (2008) resulted in failure of number of Banks and, consequently
the Basel III Capital adequacy norms have been made applicable to Banks. As a
result, Banks have become increasingly constrained in their ability to lend money
to the ventures or start-ups which may have high risk element. Hence, there is a
need for funding for SME through alternative sources.
iii. SMEs are able to raise funds at lower cost of capital without undergoing through
rigorous procedures in this mode.
iv. Crowdfunding provides new investment avenue and provides a new product for
portfolio diversification of Investors.
v. It increases competition in a space traditionally dominated by a few providers
(providing finance to Start-ups and SMEs).
vi. The operators of a crowdfunding platform may engage in vetting or due diligence
of projects to be included on their website, to maintain the reputation of the
website.

5.0 Risks of Crowdfunding

5.1 Substitution of Institutional Risk by Retail Risk

5.1.1 Presently, the risk in financing Start-ups and SMEs is borne by the Venture Capital
Funds (VCFs) and Private Equity (PE) Investors. In crowdfunding, these entities solicit
investments in smaller sums from large number of investors. Hence, the risk taking by
VCF/PE (informed investors) is substituted with retail investors, whose risk tolerance
level may be very low. Retail investors may not be able to understand the risk in these
investments and will be unable to bear the loss of investments.

5.1.2 This may be more dangerous, considering the fact that investments in SMEs and
Start-up may involve high risk and low liquidity and are generally treated as aggressive
and long term investments. VCF/PE Investors will be able to negotiate a better pricing

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and some influence on management, which would be absent in the Crowdfunding
Route, where smaller contributions are sought from multiple investors. Uninformed and
unsophisticated investors (retail investors) may act with a ‘herd mentality’.

5.2 Risk of default

5.2.1 There is no or less recourse to the investors against the issuer, in case of default
or fraud. Funds are not directly solicited by the issuer and issuer also do not come out
with any offer document. Funds are solicited by the platform and such platform may or
may not conduct proper due diligence of the issuer. If a platform is being temporarily
shut down, or closed permanently, no recourse is available to the investors.

5.2.2 There is no collateral (even in case of peer to peer lending), as in case of

Corporate Bonds. Further, in peer to peer lending, there are no investor protection by
way of a compensation scheme to cover defaults like deposit guarantee schemes for
bank deposits.

5.2.3 Public funding is sought on the basis of future possibilities as against the clear
evidence of a viable existing business model, which is needed under the existing
regulations. Investments in companies without viable business model increase the risk
of failure and loss to equity investors.

5.2.4 The risk of failure is further increased by the fact that the funding is potentially by
participants who do not have the skills and experience needed to assess the risk before
investing/lending, as compared to the VCF/PE Investors, banks or other financial
institutions who provides funds under the traditional business model.

Eg: Bubble and Balm was a fair trade soap company, who were also the first
company to raise funding for their start-up through the equity crowd-funding
platform Crowdcube, based in the UK, in 2011. It raised £75,000 in return for 15
per cent of the company’s equity from 82 investors, who contributed between £10
and £7,500 each. In July 2013 the business closed overnight, leaving no way of

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 contacting the company or a way to recover losses. The investors lost 100% of
their investment. 4

5.3 Risk of Fraud

5.3.1 There is possibility of genuine websites being used by fraudsters claiming to be
promoters of projects or of false websites being established, simply to defraud the
investors or to entice individuals to provide credit card details etc. Thus, there is a risk of
misuse as well as cyber-security and/or identity theft.

5.4 Central role of the Internet:

5.4.1 Crowdfunding platform is an internet based market place for issuers to sell their
own securities to raise capital. Thus the central role of the Internet and its wide reach
would increase the number of persons potentially affected, which can be significantly
greater than the traditional means of fundraising. Younger investors may get influenced
simply because of its link to social media and the Internet.

5.4.2 Funds could be raised from investors residing at various countries without
complying with requirement of local laws of various jurisdictions.

5.5 Systemic Risk:

a) Due to the “individual” nature of crowdfunding, there is a possibility that
investors may not practice good diversification principles.
b) There may be no secondary market in which investors can sell their
investments and exit and hence, there is a risk of illiquidity.
c) There is also possibility of Money laundering.
d) These platforms could expose other financial sectors to the risk of default, as
occurred during the subprime mortgage crisis. If the rapid growth rate in peer-
to-peer lending continues, these risks could become systemic.
e) There are Cross-border implications, if the funds are solicited through
internet, as there are disparities in Contract Act or securities law application in
different jurisdictions.

4
IOSCO Staff Working Paper - Crowd-funding: An Infant Industry Growing Fast , 2014

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5.6 Information Asymmetry
a) There is high chance of information asymmetry associated with these
platforms, where one party invests/trades based on some information which is
unknown to other set of investors. Since there is lack of hard information,
there is too much reliance on soft information based on the social networking
platforms in this model, which increases the risks.
b) There is no monitoring of these platforms, as to which account the money
goes.
c) There is lack of transparency and reporting obligations on issuers including
with respect to the use of funds raised.
d) There is possibility of omission of information and misinformation providing
distorted view of the issuer or the actual investment, which may result in over-
estimation of the actual return. This may induce the investors to invest in a
product that would not align with their risk tolerance.

5.7 Substitution of Existing Regulatory Framework

5.7.1 Peer to Peer Lending acts as a Bank by matching lenders/investors with
borrowers/issuers, without complying with any of the rigid requirements of Banks.

5.7.2 The Disclosure and due diligence involved in Crowdfunding platform cannot be
compared with existing framework of public offering through filing of Prospectus with
adequate information, which is also subject to the scrutiny of the Regulators. Further,
other public issue requirements for equity shares like to have minimum track record for
the issuers, minimum promoters' contribution, lock in, and for debt securities like
requirement to have trustees, rating by Credit rating agencies etc. may not be
applicable in the crowdfunding platforms.

5.7.3 Further, even private placement requirements have been tightened in India
recently i.e. requirement to have Private Placement Offer Letter, restriction on number
of investors to whom it can be made, restrictions on mode of placements, etc.
Crowdfunding Platforms may not adhere to any of the said requirements.

Page 8 of 66
6.0 Regulatory framework for Crowdfunding in various Jurisdictions:
6.0.1 As of date, very few jurisdictions have come out with regulations for crowdfunding.
Some jurisdictions are in the initial stages of introduction with concept papers for
feedback of the industry.

6.0.2 Two areas that have seen rapid growth in recent years are Peer-to-Peer Lending
and Equity Crowdfunding. Financial Reward (FR) crowd-funding globally has grown
rapidly in the last 5 years, with data suggesting that the peer-to-peer lending market
doubles each year. It accounts for approximately $6.4 billion outstanding globally.
Collectively, the US, UK and China make up 96% of the overall FR crowdfunding
market, with USA accounting for 51%, China for 28% and UK for 17%. 5.

6.1 Regulatory Practices

In Donation crowdfunding and Reward crowdfunding, only donations or grants are
solicited and no financial return in the form of a yield or return on investment is expected
by the donor/grantor. Hence, such funding mostly falls outside the purview of Securities
market regulator. (In India, payment of donations are mainly governed by the provisions
of Income Tax Act). Peer-to-Peer Lending, depending upon whether pure lending or any
debt securities are issued, are regulated by Banking or Securities market regulator.
Crowd Sourced Equity Funding are mostly regulated by Securities market regulator.

6.2 Regulation of Peer-to-Peer lending

6.2.1 Peer-to-Peer lending is also termed as 'direct consumer lending' or 'marketplace
lending'. The Peer-to-Peer lending is approached differently by various regulators,
treated as banking by some jurisdictions and as an intermediary in some others, while
some jurisdictions like Israel and Japan have prohibited it altogether.

6.2.2 As per IOSCO Paper5, though the nature of regulations concerning Peer-to-Peer
Lending varies with nations, these can be broadly divided into different categories.

5
'Crowd-funding: An Infant Industry Growing Fast' Staff Working paper of IOSCO Research Department

Page 9 of 66
Regulatory Description Countries
Regime
Unregulated In these jurisdictions either Brazil, China,
the regulation has classified peer-to-peer lending as Egypt, South
an exempt market or there is a lack of definition in Korea
legislation
Intermediary This regulates peer-to-peer lending platforms as an Australia,
Regulation intermediary. This usually requires registration of such Argentina,
platform as an intermediary, and other regulatory Brazil, New
requirements depending on the jurisdiction. Zealand
Banking This regulated peer-to-peer lending platforms as France,
Regulations banks. Germany,
Italy
US Model This is a two tier system. This requires the registration USA
of peer-to-peer lending platforms with the SEC, as
well as applying for a licence to conduct business on a
state by state basis.
Prohibited Both peer-to-peer lending Israel, Japan
and equity crowd-funding are banned under legislation

6.3 Regulation of Equity Crowdfunding

In case of Equity Crowdfunding, most jurisdictions have enabled it as an exemption to
general requirements regarding public solicitation through prospectus/offering
memorandum. While in some jurisdictions such exemption is given only to offer made to
“accredited/informed/wealthiest” investors, others exempts solicitation made through
“Crowdfunding Platform” capping the amount that can be raised or the amount that can
be invested by each investor.

Page 10 of 66
6.4 Regulation of Crowdfunding in various Jurisdictions:

6.4.1 United States

Jumpstart Our Business Startups Act, 2012 or (JOBS Act) has already proposed a basic
regulatory framework to regulate Crowdfunding Platforms.

Previously, in U.S. there was a ban on ‘general solicitation’ or ‘general advertising’ of

investment in securities, other than a prospectus-based offer.

Title II of the JOBS Act deals with equity offers to accredited investors. Pursuant to SEC
Rules under that Title, in effect from September 2013, US entrepreneurs may publicly
advertise and market their company’s investment opportunity, of whatever size, to
‘accredited investors’ (in effect, individuals with over $1 million in liquid net worth or
annual incomes over $200,000), including through the Internet or social media, as well
as through print, radio or television.

Title III of the JOBS Act deals with Crowd Sourced equity Funding (CSEF) offers to
investors generally. It is intended to allow start-up and other companies to use online
intermediaries to obtain modest amounts of capital. Title III of the Act, the crowdfunding
provision, has not yet come into force.

Under this act, for a transaction to be qualified as a crowdfunding transaction, it must

meet specified requirements, including the following:
• the amount raised not to exceed $1 million in a 12-month period (this amount is
to be adjusted for inflation at least every five years).
• individual investments in a 12-month period are limited to:
o the greater of $2,000 or 5 percent of annual income or net worth, if annual
income or net worth of the investor is less than $100,000; and
o 10 percent of annual income or net worth (not to exceed an amount sold
of $100,000), if annual income or net worth of the investor is $100,000 or
more (these amounts are to be adjusted for inflation at least every five
years); and

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 • transactions must be conducted through an intermediary that either is registered
as a broker or is registered as a new type of entity called a “funding platform.”
• Crowdfunding requires the issuing company (emerging growth company) to file a
disclosure document with SEC at least 21 days prior to first sale, and requires
scaled financial disclosure, including audited financial statements for raises of
over $500,000.
• Annual reports must be filed with SEC by the issuer company which completes a
crowdfunding round.
• Funding platforms (but not broker-dealers) cannot: offer investment advice or
make recommendations to investors. They cannot solicit transactions for
securities offered or displayed on its platform, or compensating employees or
agents for doing so. They cannot hold or manage any investor funds or
securities.

In the US, Kickstarter enabled creative individuals—musicians, filmmakers, writers—to

fund their work, often with the only return being an advance copy or limited edition of a
6
DVD or other art work, concert tickets, or a signed thank-you note.

6.4.2 New Zealand

The recently enacted Financial Markets Conduct Act, 2013 (the Act) contains provisions
designed to facilitate CSEF.

The new regulations in New Zealand enables companies to raise up to a maximum of $

2 Million from 20 investors in a year through crowdfunding without having to issue a
prospectus. It covers both the varieties of crowdfunding: Equity Crowdfunding and Peer-
to-Peer Lending.

The market regulator, Financial Markets Authority, has asked both, equity crowd-
funding platforms and peer-to-peer lenders, to apply for a license to operate.

6
Crowd Based Equity Funding – Discussion Paper - Corporations and Markets Advisory Committee, Australia, September , 2013

Page 12 of 66
 6.4.3 Australia
The Corporations and Market Advisory Committee (Australian Government) recently
came out with a Concept Paper on Crowdfunding and is currently in the process of
framing rules for equity based crowdfunding.

The current regulations allow a startup to raise not more than $ 20 Million or transfer
equity to more than 20 people in any given 12 months. This system restricts this
channel to a set of sophisticated investors. These rules are under revision.

6.4.4 Canada
Crowdfunding is divided into Non-Equity and Equity Crowdfunding platforms in
Canada. Equity Crowdfunding involves the issuance of securities and consist of peer-to-
peer (P2P) lending and equity transactions.

Canadian Securities Administrators (CSA), an umbrella organization for different

provincial and territorial securities regulators in Canada, has published National
Instrument (in 2014) involving prospectus exemptions that include the Offering
Memorandum exemption (the OM exemption) which is used by registered dealers to sell
securities on the internet to the public. The OM exemption is available in all jurisdictions
in Canada, except Ontario, and has been in place for many years.

There are registration requirements for Crowd Sourced Equity Funding Platforms,
including Integrity, proficiency and solvency requirements, and for the persons operating
them.

Registration requirement addresses concerns relating to possible conflicts of interest

and self-dealing by intermediaries and to avoid fraudulent offerings of securities to
investors through the Internet.

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 6.4.5 United Kingdom
In March, 2014 Financial Conduct Authority (FCA) came out with regulations governing
the crowdfunding in Britain. The new regime will be applicable to the firms operating
loan-based crowdfunding platforms and investment-based crowdfunding platforms.

Loan-Based Crowdfunding Platforms: These include peer-to-peer lending platforms

or peer-to-business lending platforms on which consumers can invest in loan
agreements.

Investment-Based Crowdfunding Platforms: These include the platforms on which

consumers can buy investments, such as equity or debt securities that are not listed or
traded on a recognized exchange, or units in an unregulated collective investment
scheme. In other words, these are' non-readily realized securities'.

Under the new regulation, investment-based crowdfunding platforms are treated slightly
differently to loan-based crowdfunding platforms by the FCA. The new regulations have
become effective from April 1, 2014. As a result, the regulation of the consumer credit
market has been transferred from the Office of Fair Trading to the FCA. This includes
responsibility for regulating loan-based crowdfunding.

New Regulations:
Loan-Based Crowdfunding Platforms:
• The new regulations intend to safe guard the interests of the investors by ring
fencing the investments from the platform's finances. Therefore in case anything
happens to the platform, the investments would not be hurt. The platforms also need
to have a contingency plan or a third party in place to ensure seamless operations.
• Platforms must also have capital reserves to cushion the effect of defaults. Each
platform will need to hold £20,000 from October this year and £50,000 from April
2017.

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• The new regulations also take a robust view on disclosures. The marketing of the
products should not be misleading and all the risks should be adequately
highlighted.
• Unlike savings or bank accounts, neither loan or investment-based crowdfunding is
covered by the £85,000 Financial Services Compensation Scheme. Thus loan-
based crowdfunding is still very much an investment, rather than savings product.
• Investors can cancel their agreement without any penalty within a cooling period of
14 days if the firm does not provide access to a secondary market.
• The new regulations provide access to the financial services ombudsman for all
complaints.

How are the new Rules different?

Many established lending-based platforms are already regulated by FCA and therefore
largely compliant to the new regulations. However, the regulations put a structure in
place for the platforms to manage their risks properly and not promise some ludicrous
return.

Investment-Based Crowdfunding Platforms:

Very similar rules apply to investment-based crowdfunding as loan-based - i.e. the
marketing must be fair and not misleading, risks should be highlighted and systems
must be in place to separate your money from theirs - and ensure there are adequate
capital reserves.

The 14 day cooling off period and access to financial ombudsman also apply.

Aside from systems requirements, there are new rules on who is actually allowed to
invest their money in crowdfunding. These include:

• retail clients who are advised,

• retail clients classified as corporate finance contacts or venture capital contacts,
• retail clients certified as sophisticated or high net worth, or
• retail clients who confirm that they will not invest more than 10 per cent of their net
investible assets in these products.

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So the onus is really on the investor to ensure they fall into one of the above brackets,
rather than the platform. Investors must to tick a box to confirm they fall into one of the
above categories.

The investors must also pass an online appropriateness test to prove they are aware of
the risks. October 1, 2014 is the deadline for the platforms to launch investor tests.

An investor can also reclassify herself as 'sophisticated' once he/she has made at least
two investments in investment-based crowdfunding.

How are the new Rules different?

• The new regulations for investment-based crowdfunding make sure that investors
don't get undue exposure and at the same time there is a scope for increasing
exposures in incremental phase by following a learning curve.
• The definition of a 'sophisticated' investor is not just restricted to the net worth but
also takes in consideration the experience and the confidence that an investor has in
such investments.
• Disclosures by the investors play a very crucial role.

6.4.6 France
The old regulations in France allowed a company to raise up to $ 1,40,000 for equity.
This amount has been raised to $ 14,00,000. But there is no maximum investment cap
specified for a particular investor, which makes the investors decide on their risk
appetite.

The new laws allows platforms to register as a crowdfunding investment advisor, which
will enable platforms to get paid by companies as well as the investors.

Like US, France has also brought in the concept of accredited investors. Previously, the
companies were only able to give the complete information (valuation, dates, percent of
ownership, etc.) concerning their fundraising to 150 potential investors. The new rules
have done away with that cap, allowing for an unlimited number of investors to pitch in
cash.

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 The need for an external audit is done away, but there is a huge impetus on extensive
disclosures by issuers both at the time of fund raising and periodically.

Companies will also be allowed to take loans from individuals for a total of up to €1
million, though the loan amount is capped at €1,000 per investor per company.

6.4.7 Japan
Financial Services Agency (FSA), Japan has promulgated an amendment in Financial
Instruments and Exchange Act on May 23, 2014 to facilitate and promote, inter alia,
Equity Crowdfunding in Japan.

The amendments pertinent to Crowdfunding are given as under:

I. Relaxation of entry requirements of Financial Instruments Business
Operators (FIBO).
(FIBO: An entity allowed to engage in the activities of trading, intermediation, brokerage,
undertaking in primary and secondary public offerings, and other businesses involving only the
securities which they are authorized for.)

Revised Regulations:
• Relaxation of Entry Requirements
o Restrictions on the conduct of other businesses would not be imposed on
crowdfunding platform operators that handle only 'small amounts' and the
minimum capital required for registration would be reduced 7.
o 'small amounts' mean that the total amount offered is less than 100 million yen
and the amount of investment per person is 500,00 yen or less.

• Establishment of Rules to protect Investors

o To prevent fraudulent behavior, crowdfunding platform operators would be
obligated to conduct checks on the businesses of the start-ups and to provide
information of issuers, etc. appropriately through the Internet.

7
Type I FIBO: 50 million yen (current) reduced to 10 million yen, Type II FIBO: 10 million yen (current) reduced to 5 million yen

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7.0 Indian Scenario

7.1. Existing Legal Framework

7.1.1 The provisions in the existing legal framework for raising funds by companies are
regulated under Companies' Act 2013 and Securities Act i.e. SEBI Act, 1992, Securities
Contracts (Regulation) Act, 1956, Depositories Act, 1996. Raising of pooled managed
investment funds by various entities such as Alternative Investment Fund (AIF), Mutual
Fund (MF) etc. is regulated under Securities Laws.

7.2. Public Issue of Securities by Companies

7.2.1 Companies making public issue of securities need to comply with public issue
requirements prescribed in Companies Act, 2013 and Rules made thereunder, apart
from the requirements of SEBI Regulations.

7.2.2 Companies Act requires a company proposing to make a public issue to make a
listing application to recognized stock exchanges. It requires the issuing company to file
a Prospectus with Registrar of Companies. Further, detailed disclosure requirements for
Prospectus are also specified.

7.2.3 Under Section 24 of the Companies Act, 2013, the provisions relating to issue and
transfer of securities by listed companies or those companies which intend to get their
securities listed on any recognized stock exchange in India shall be administered by
SEBI. Hence, SEBI regulates public issuance of securities and those private
placements which are proposed to be listed on stock exchange(s).

7.2.4 SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (ICDR)
requires issuers making public issue of specified securities to comply with requirements
prescribed there-in which includes appointment of merchant banker, registrar to issue,
filing of draft offer document with SEBI, eligibility requirement such as track record,
minimum promoter’s contribution, lock-in requirements, requirement to have a
monitoring agency, etc., apart from detailed disclosure requirements.

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7.2.5 However, in case of debt securities, there is a simpler regime and the issuer need
to comply with SEBI (Issue and Listing of Debt Securities) Regulations, 2008 (ILDS),
which requires compliance with basic requirements like having a Debenture trustee,
Credit Rating, disclosure requirements, etc.

Further, once securities are listed in a Recognized Stock Exchange, the issuer has to
comply with the continuous listing requirements.

7.3. Private Placements of Securities by Companies

7.3.1 Taking into account the recent misuse of private placement route by some
companies which issued huge number of debt securities to public under the garb of
private placements, Companies Act, 2013 and Rules made thereunder, have put some
restrictions on private placements, which was previously lightly regulated.

7.3.2 As per Chapter III - The Companies (Prospectus and Allotment of Securities)
Rules, 2014 , in case of a private placement of securities, private placement offer or
invitation cannot be made to more than 200 persons in the aggregate in a financial
year (excluding Qualified Institutional Buyers and employees of the company being
offered securities under a scheme of employees stock option).

7.3.3 Such offer can be made only to such persons whose names are recorded by
the company prior to the invitation to subscribe, and that such persons shall receive
the offer by name, and that a complete record of such offers shall be kept by the
company and complete information about such offer shall be filed with the Registrar
within a period of thirty days of circulation of relevant private placement offer letter.

7.3.4 All monies payable towards subscription of securities through private placement
shall be paid through cheque or demand draft or other banking channels but not by
cash. Further, rules require that the payment to be made for subscription to securities
shall be made from the bank account of the person subscribing to such securities and
the company shall keep a record of all such bank accounts. The company shall allot its

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securities within sixty days from the date of receipt of the application money for private
placement, else money has to be repaid to the investors.

7.3.5 Company offering securities through private placement shall not release any
public advertisements or utilize any media, marketing or distribution channels or
agents to inform the public at large about such an offer.

7.3.6 Ministry of Corporate Affairs has also notified Companies (Prospectus and
Allotment of Securities) Rules, 2014. As per the said Rules, a private placement offer
letter shall be accompanied by an application form serially numbered and addressed
specifically to the person to whom the offer is made and no person other than the
person so addressed in the application form shall be allowed to apply through such
application form. The value of such offer or invitation per person shall be with an
investment size of not less than Rs.20,000 of face value of the securities.

7.3.7 A return of allotment of securities shall be filed with Registrar of Companies within
30 days of allotment along with a complete list of all security holders containing the full
name, address, Permanent Account Number and E-mail ID of such security holder.

7.3.8 Companies Act, 2013 mentions that any offer or invitation that is not in compliance
with the provisions of Section 42 shall be treated as a public offer and all provisions of
Companies Act, 2013, and the Securities Contracts (Regulation) Act, 1956 and the
Securities and Exchange Board of India Act, 1992 shall be required to be complied with,
including the above mentioned requirements.

7.3.9 However, as mentioned above, Companies Act, 2013 provides a window for
making private placement offers to Qualified Institutional Buyers (QIBs) and the 'limit of
200' is not applicable to such QIBs. QIBs are the entities such as a MF, Foreign
Portfolio Investor (FPI), AIF, Scheduled Commercial Bank, IRDA registered Insurance
company etc. as defined in SEBI (Issue of Capital and Disclosure Requirements)
Regulations, 2009.

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 7.4. Provisions regarding SME Funding
7.4.1 SEBI has taken various steps in the recent past to enable Start-ups and SME to
raise funds through various routes such as SME Segment of Exchanges, Institutional
Trading Platform (ITP), Category I- SME Fund under AIF Regulations. These channels
are briefly defined in the following sections:

7.4.2 SME Segment

7.4.2.1 SEBI has specified framework for a SME segment (platform) on Recognized
Stock Exchanges, where Small and Medium Enterprises (SME) can list their securities.
A company which has its post-issue face value capital not exceeding ten crore rupees
shall list only in SME platform. A company, which has its post issue face value capital
more than ten crore rupees and upto twenty five crore rupees, has an option to list in
SME platform. In case the post-issue face value capital exceeds Rupees twenty five
crore rupees, the issuer should compulsorily list only on main board of the Stock
Exchanges.

7.4.2.2 However, a listed issuer whose post-issue face value capital is less than twenty
five crore rupees may migrate to SME platform if its shareholders approve such
migration by passing a special resolution through postal ballot. An issuer listed on SME
exchange proposing to issue further capital pursuant to which their post-issue face
value capital may increase beyond Rs. 25 crore shall migrate to the main board, subject
to obtaining in-principle approval of the main board before issue of such securities.

7.4.2.3 Various relaxations have been provided to SMEs listing on SME segment under
SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009. Some of them
are:
• Draft Offer document may be filed directly with the exchange and not necessarily
with SEBI.
• Eligibility criteria for an issuer under Regulation 26 is not applicable to companies
listing under SME segment.

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 • Minimum application value of Rs.5000-7000 is not applicable (min. application
value shall not be less than Rs. one lakh per application).
• Minimum number of prospective allottees is fifty (instead of 1,000 in Main board).

7.4.2.4 Similarly, relaxations have also been provided with respect to the continuous
listing requirements for Companies listed in SMEs:
• Requirement to file half yearly financial results instead of quarterly
• Exemption from publishing financial results in newspaper
• SME companies may send abridged annual report to their shareholders.
However, the same need to be displayed on the website of the exchange and
company.

7.4.2.5 Apart from the above, there is a compulsory market making requirement for
companies listed on SME segment for a minimum period of three years from the date of
listing to ensure liquidity in the market.

7.4.2.6 SME Segments were launched on BSE and NSE on December 14, 2012 and
September 18, 2012 respectively. There are 60 SMEs listed on the BSE SME Exchange
and 5 SMEs listed on the NSE SME Exchange (Emerge) as on June 11, 2014.

7.4.3 Institutional Trading Platform (ITP)

7.4.3.1 SEBI has permitted listing of Small and Medium Enterprises (SME), including
start-up companies, on the SME exchange Institutional Trading Platform (ITP), without
being required to make an initial public offer. The main features of the ITP Platform
following are:
• Only such SMEs which do not have their securities listed on any recognized
stock exchange are permitted to list their specified securities exclusively on the
ITP.
• The listing process of ITP does not involve an IPO, or private placement or any
issue of securities.

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 • While such companies are listed on the platform, they are not permitted to raise
capital.
• Since the trading lot has been mandated as 10 lakh, participation in this platform
is restricted to informed investors.
• The companies listed in ITP are SMEs and start-up companies which get visibility
by listing in the stock exchanges, without any public issue of their securities.
• The regulatory framework for ITP also envisages that the SMEs listed in this
platform will mandatorily exit the platform if (a) a period of 10 years have elapsed
since the company was listed in the ITP (b) the paid-up capital of the company is
more than twenty five crore rupees (c) the revenue of the company is more than
three hundred crore rupees (d) company reaches market capitalization of more
than five hundred crore rupees.

7.4.3.2 This platform is merely meant to provide the initial impetus for such SMEs rather
than a sustained listing over a long term horizon.

7.4.3.3 In addition to the visibility to SMEs, this framework also provides a trading
platform for the scrips of Start-up Companies held by Alternative Investment Funds
(AIFs), VCFs etc. and enhances the liquidity in such scrips, which in-turn provide
enabling environment for SME and start-up enterprises to flourish.

BSE launched its ITP on February 11, 2014. There are 6 companies listed on ITP of
BSE. NSE launched its ITP on October 28, 2013 and there is 1 company listed on it as
on June 11, 2014.

7.5. Provisions related to Alternative Investment Funds:

7.5.1 SEBI (Venture Capital Funds) Regulations (“VCF Regulations”) were framed in
1996 to encourage funding by entrepreneurs’ early-stage companies in India. However,
since registration of VCF was not mandatory under VCF Regulations, all players in the
alternative funds industry were not registered with SEBI. Hence, it was felt that there
was a regulatory gap which needed to be addressed. Further, SEBI Board had

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approved the proposal for a clear regulatory framework for privately pooled investment
vehicles under AIF framework to inter-alia pave way for increased investment in start-
ups, SMEs, etc. and also provide for a mechanism to monitor and assess systemic risks
and risks to financial market stability posed by the activities of some funds such as
Hedge funds.

7.5.2 Considering the same, SEBI notified the framework for registering and regulating
Alternative Investment Funds (AIF) through SEBI (Alternative Investment Funds)
Regulations, 2012 on May 21, 2012.

7.5.3 These Regulations cover all privately pooled investment vehicles in India raising
funds from Indian or foreign investors for investing in accordance with a defined
investment policy for the benefit of its investors. However, Mutual Funds, Collective
Investment Schemes, Family Trusts, Employee Welfare trusts, Securitization trusts, any
other funds regulated by other regulators, etc. are exempted from the ambit of the AIF
Regulations.

7.5.4 These regulations seek to cover the funds broadly under 3 categories.
• Category I – which includes Venture Capital Funds, SME Funds, Social Venture
Funds, Infrastructure Fund, etc. (which invests in sectors or areas which the
government or regulators may consider as socially or economically desirable);
• Category II – which includes private equity funds or debt funds (which does not
undertake leverage or borrowing other than to meet day-to-day operational
requirements) and
• Category III – which includes Hedge Funds - (employ leverage including through
investment in derivatives)

7.5.5 As per the said Regulations, AIF should be prohibited by its trust
deed/memorandum and articles of association/partnership deed from making an
invitation to the public to subscribe to its securities. AIF shall not accept from an investor
an investment of value less than Rs. 1 Crore and no scheme of the AIF shall have more

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than 1,000 investors. Further, each scheme of the AIF shall have a minimum corpus of
Rs. 20 crore. Further, the manager or sponsor shall have a continuing interest in the AIF
of certain percentage of the corpus.

7.5.6 Category I AIFs are further categorized in 4 sub-categories: (i) Venture Capital
Funds (ii) Social Venture Funds, (iii) SME Funds, (iv) Infrastructure Funds.

i. Social Venture Funds:

An AIF which invests primarily in securities or units of social ventures and which
satisfies social performance norms laid down by the fund and whose investors may
agree to receive restricted or muted returns may get itself registered as a Social
Venture Fund under SEBI (Alternative Investment Funds) Regulations, 2012. It can
accept investment which is not less than one crore and such investor may accept muted
returns. Such funds are also entitled to accept grants, provided that utilization of such
grants shall be restricted to social ventures. Further, the amount of grants that may be
accepted by the fund from any person shall not be less than Rs. 25 Lakhs and no profits
or gains shall accrue to the provider of such grants.

There are 3 Social Venture Funds registered with SEBI with

a corpus of Rs. 820-900 Crores as on June 11, 2014.

ii. SME Funds:

An investment fund which invests primarily in unlisted securities of investee companies
which are SMEs or securities of those SMEs which are listed or proposed to be listed on
a SME exchange or SME segment of an exchange may get itself registered as an SME
Fund. Such funds:
• shall invest at least 75% of the investible funds in unlisted securities or
partnership interest of venture capital undertakings or investee companies which
are SMEs or in companies listed or proposed to be listed on SME exchange or
SME segment of an exchange
• may enter into an agreement with merchant banker to subscribe to the
unsubscribed portion of the issue or to receive or deliver securities in the process

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 of market making under Chapter XB of the Securities and Exchange Board of
India (Issue of Capital and Disclosure Requirements) Regulations, 2009

There are 5 SME funds registered with SEBI with corpus in the range of Rs. 1,625 -
2,125 Crores as on June 11, 2014.

iii. Angel Funds:

Under SEBI (Alternative Investment Funds) Regulations, 2012, a sub-category has
been created under Category I – Venture Capital Funds called “Angel Funds” vide
amendment dated September 16, 2013. Such funds can raise funds from angel
investors and make investments in start-ups/early stage companies.

In order to ensure that investment by such angel funds is genuine 'angel investment' in
India, it is prescribed that the investee companies:
a. are incorporated in India and are not more than 3 years old; and
b. have a turnover not exceeding Rs 25 crore; and
c. are unlisted, and
d. are not promoted, sponsored or related to an Industrial Group whose group
turnover is in excess of Rs. 300 crore, and
e. has no family connection with the investors proposing to invest in the company.

Investment in an investee company by an angel fund shall not be less than Rs. 50 lakhs
and more than Rs. 5 crore. Such conditions are expected to ensure that the investments
are genuine investments in start-ups/ early stage companies in India.

Minimum Corpus of an Angel Fund shall be Rs.10 Crores. Minimum investment from
each investor shall be Rs. 25 Lakhs. As Angel investments are highly risky investments,
necessary restrictions are imposed on the eligibility of the investors in order to ensure
that only investors who have prior experience/ adequate awareness of such
investments and who have sufficient capital invest in such funds. Reduced mandatory
minimum sponsor/manager contribution is made applicable to Angel Funds comparing
to other AIFs, i.e. 2.5% of the corpus/ Rs. 50 lakhs, whichever is lesser.

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There is 1 Angel Fund registered with SEBI as on June 11, 2014.

8.0 Is Crowdfunding really needed ?

8.1 As mentioned earlier, the 2008 financial crisis resulted in failure of number of Banks
and, consequently, the new capital adequacy regulations for banks, such as Basel III
were implemented. As a result, credit providers have become increasingly constrained
in their ability to lend money to the real economy.

8.2 IOSCO Paper states that the amount of bank loans made in Western Europe and
the USA dropped significantly at the beginning of the crisis. While there have been
some signs of recovery in the US (although the growth rate is still below pre-crisis
levels), in Western Europe the growth rate in loans to the non-financial corporate sector
has been negative, especially to SMEs in the EU. In this funding vacuum, peer-to-peer
lending and other Crowdfunding Platforms are growing in popularity, as bank liquidity is
reduced and new regulatory requirements make obtaining loans for small and medium
enterprises and individuals difficult.

8.3 In India, during the last few years, the IPO market has not been very active.
Though, SEBI, has been at the forefront in facilitating fund raising by SMEs through
measures like SME segment in Stock Exchanges, Category I- SME funds under AIF,
Institutional Trading Platform, etc., still there is need to encourage innovative way of
fund raising to provide an impetus to genuine SMEs/Start-ups and to explore other
alternative models of fund raising with appropriate framework in consonance with retail
investor protection.

8.4 Since the "Crowdfunding" phenomenon is gaining its popularity, its importance
cannot be ignored. To regulate crowdfunding, it is very important to take note that while
it is necessary to ensure that Start-ups/SMEs could raise funds at ease, it is equally
important to ensure that no systemic risks are created wherein retail investors are lured
by some unscrupulous players by substituting the existing framework, which has been
developed over a period of time through experience and observation. Hence, there is

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necessity to strike a proper balance between investor protection and the role equity
markets can play in supporting economic development and growth.

8.5 While some regulators are criticized by media from “taking the crowd out of
crowdfunding', 8 there are also media reports explaining the risks in the model and
stating that regulators who are today denounced for their intervention will then be
castigated for their neglect. 9

8.6 IOSCO Paper states that "A risk posed by moving to regulate a previously exempt
sector is the perceived rubber stamping of the industry through regulation, creating
credibility in the peer-to-peer lending and equity crowd-funding markets.

This could attract less experienced investors to these markets who may not understand
the risks involved in these types of investment.

8.7 Therefore it would be appropriate for regulators to take appropriate stand in this
regard and send out a message to the various stakeholders recognizing this emerging
route of funding. India, so far, does not face a significant exposure to crowdfunding but
given that this mode of fund raising is growing at a scorching pace, it is important that
regulators keep an open eye and a vigilant attitude.

Question 1: Given that Crowdfunding is still in nascent stages and most of the
jurisdictions around the world have taken a guarded view by allowing it in a
restricted manner, do you think India is ready for crowdfunding or is it premature
to introduce such risky investment channel ?

8
http://www.theguardian.com/technology/2014/mar/06/crowdfunding-regulator-10-percent-rule
9
http://www.johnkay.com/2014/03/25/regulators-will-get-the-blame-for-the-stupidity-of-crowds

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9.0 Proposal for Crowdfunding in India
9.0.1 SEBI has provided various frameworks for raising of funds by startups, SMEs etc.
as specified in the paragraph 7. In addition to the available frameworks, SEBI seeks to
provide fresh avenues for startups and SMEs set up by young entrepreneurs and
technology professionals to raise early stage funding through internet based platforms,
potentially more efficiently and cost effectively than through public issue or private
placement offering.

9.0.2 Crowdfunding is an innovative way to provide modest amount of funding to young

entrepreneurs and technology professionals needing early stage or seed capital for
startup companies which may spur entrepreneurship and ultimately assist in boosting
the growth of real economy.

9.0.3 A company raising funds through online crowdfunding platforms or websites offers
equity or debt interests in its business to investors who make small contributions,
through a crowdfunding platform or social media. In most of the cases funding is sought
online on the basis of future projections rather than a viable business model in operation
which increases the risk of failures and therefore loss to the investors.

9.0.4 If the costs associated with regulatory provisions for investor protection are
excessive, crowdfunding may not become a viable capital raising method. At the same
time investors would be concerned about the risks of crowdfunding and may not be
prepared to invest if there are no adequate safeguards in place. Therefore the proposal
seeks to strike a balance between retail investor protection and capital market access to
such ventures by providing adequate investor safeguard without creating too many
entry barriers or significant regulatory burdens on the issuers.

9.0.5 Pure Donation Based Crowdfunding (where issuers directly seek donation from
the grantors), Reward Based Crowdfunding (where issuers directly offers rewards like
movie tickets, new computer game, download of a book etc.) and Peer-to-Peer lending
do not fall within the regulatory purview of SEBI, as they do not generally involve

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issuance of securities for financial return, and may require authorization from other
regulators. For example, Peer-to-Peer lending may fall under the purview of RBI.

9.0.6 Taking into account various provisions under the Indian law and crowdfunding
framework in other jurisdictions, this proposal seeks to explore the possibilities of having
Security Based Crowdfunding framework in India within the existing legal framework.

9.0.7 Crowdfunding is intended to facilitate raising of modest amount by startups and

SMEs for early stage funding and it is not necessary or appropriate to allow certain
complex or hybrid products. Under the Security Based Crowdfunding, the possible
routes which are being explored are as follows:

1. Equity based Crowdfunding (EbC)

2. Debt based Crowdfunding (DbC)
3. Fund based Crowdfunding (FbC)

9.0.8 In all the approaches, the Crowdfunding Platform plays a central role where
investors can meet promising start up companies. The web based crowdfunding
platform will facilitate raising of capital through its website from investors who have
access to such platform. The first 2 routes are primarily based on the Private Placement
route as defined under Section 42, Companies Act 2013. The FbC route is primarily
modeled on SEBI (AIF) Regulations, 2012.

9.0.9 Before dealing with these routes it is important that the following are established:
• the investors that are allowed to invest through the crowdfunding platforms,
• the types of entities that are allowed to raise funds through this channel and the
disclosure requirements,
• the types of entities that are allowed to set up internet based Crowdfunding
Platforms to enable online solicitation from such investors,

and the different associated aspects.

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9.1 Who can be the Investor?
9.1.1 Various jurisdictions have imposed different restrictions on investments and
categories of investors who are allowed to invest in companies which are displayed on
such internet based crowdfunding websites or platforms, such as:

Jurisdiction Limitations on Investment under Crowdfunding

In a 12 month period, investors are allowed to invest
• $2,000 or 5 percent of their annual income or net worth, whichever is
greater, if both their annual income and net worth are less than
USA $100,000.
• 10 percent of their annual income or net worth, whichever is greater,
if either their annual income or net worth is equal to or more than
$100,000.
• No limit for investors advised by professionals, linked to corporate
finance or venture capital firms, or those certified as sophisticated or
UK high net worth.
• Not more than 10% of assets - excluding homes and pensions, for
other investors.
One of the option proposed is that the investor needs to be
Australia sophisticated i.e. have assets of worth at least $ 2.5 million or have a
gross income of at least $ 250,000 for each of the last 2 financial years.
France €1,000 per campaign
Canada A maximum of $2,500 in a single investment and $10,000 per year

9.1.2 It is necessary that the investors who seek to invest in crowdfunding understand
the inherent risks involved in the speculative nature of start-up companies and illiquid
nature of their securities and can bear the loss of the entire investment.

9.1.3 In Indian scenario, considering the necessity to provide alternative funding sources
to Start-ups and at the same time to ensure that retail investors are not made to bear

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the risks of Start-up ventures, it is proposed to permit only Accredited Investors to
participate in crowdfunding.

9.1.4 The Accredited Investors:

9.1.4.1 The proposed accredited investors who may be allowed to invest through
crowdfunding platforms are as under:
• Qualified Institutional Buyers (QIBs) as defined in SEBI (Issue of Capital and
Disclosure Requirements) regulations, 2009 as amended from time to time,
• Companies incorporated under the Companies Act of India, with a minimum net
worth 10 of Rs. 20 Crore,
• High Net Worth Individuals (HNIs) with a minimum net worth Rs. 2 Crores or
more (excluding the value of the primary residence or any loan secured on such
property), and
• Eligible Retail Investors (ERIs):
o who receive investment advice from an Investment Adviser, or
o who avail services of a Portfolio manager, or
o who have passed an Appropriateness Test (may be conducted by an
institution accredited by NISM or the crowdfunding platforms),
and
o who have a minimum annual gross income of Rs. 10 Lacs,
o who have filed Income Tax return for at least last 3 financial years,
o who certify that they will not invest more than Rs. 60,000 in an issue
through crowdfunding platform,
o who certify that they will not invest more than 10% of their net worth
through crowdfunding. (Net worth excludes the value of the primary
residence or any loan secured on such property).

9.1.4.2 Thus those retail investors who have knowledge, experience or have access to
investment advice and have resources to cope with the losses on their investments in a

10
Net Worth is calculated as the aggregate value of paid up equity capital plus free reserves (excluding reserves
created out of revaluation) reduced by the aggregate value of accumulated losses and deferred expenditure not
written off, including miscellaneous expenses not written off.

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start up, are eligible to invest as ERI in crowdfunding and come within the category of
accredited investors.

Question 2: Are the Accredited Investors mentioned in paragraph 9.1.4 suitable to

participate in the risky investments of crowdfunding? Is there a need to expand or
reduce the categories of investors or expand or reduce safeguards? Specify along
with the rationale.

9.1.5 Investment Limits:

9.1.5.1 Chapter III - The Companies (Prospectus and Allotment of Securities) Rules,
2014 specifies that in case of a private placement of securities the offer or invitation to
subscribe shall not be made to more than 200 investors in a financial year. Any offer or
invitation made to QIBs or to employees of the company under a scheme of employees
stock option shall not be considered while calculating the limit of 200 persons.

Therefore, EbC and DbC shall allow private placement offers through internet based
crowdfunding platforms to any number of QIBs and a maximum of 200 HNIs and ERIs
combined.
9.1.5.2 In some jurisdictions, e.g.in Italy professional investors must own at least 5% of
the equity in a crowdfunded venture. The apparent intention is to give some form of
comfort to retail investors that the issuer is genuine as one or more sophisticated
investors have chosen to invest. It is therefore proposed that QIBs, Companies and
HNIs should be required to own at least a certain percentage in every issue through
EbC and DbC.

9.1.5.3 Chapter III - The Companies (Prospectus and Allotment of Securities) Rules,
2014 specifies that in case of a private placement of securities, the minimum offer
value per person must be at least Rs. 20,000 of the face value of the securities. In
view of the above, we propose that:

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 • A QIB is required to purchase at least 5 times of the minimum offer value per
person as specified in the aforementioned rule. Collectively all the QIBs shall
hold a minimum of 5% of the securities issued.
• A Company is required to purchase at least 4 times of the minimum offer value
per person as specified in the aforementioned rule.
• A HNI is required to purchase at least 3 times the minimum offer value per
person.
• An ERI is required to purchase at least the minimum offer value per person. The
maximum investment by an ERI in an issue shall not exceed Rs. 60,000. The
total of all investments in crowdfunding for an eligible retail investor in a year
should not exceed 10% of its net worth.

Question 3: Are the Investment Limits specified in paragraph 9.1.5 justifiable with
respect to the respective investor classes? Are they too high or too low? Specify
along with rationale.

Question 4: Is the limit of investors upto 200 besides QIBs or employees of the
company under a scheme of employees stock option, as specified in Chapter III -
The Companies (Prospectus and Allotment of Securities) Rules, 2014, adequate or
is there a need to amend such rules to allow upto 1,000 investors, excluding QIBs
or employees of the company under a scheme of employees stock option?

9.1.6 Investment Conditions:

• The ERIs and HNIs must sign a 'Risk Acknowledgement' that they understand
the risk of illiquid nature of investment and potential loss of entire investment,
and that they can bear the loss.
• The issue has to be in Demat form thus all the accredited investors need to hold
a demat account.
• The payment has to be made through a cheque or a demand draft or another
banking channel. Payment by Cash and Credit Cards shall not be accepted.
• The ERIs must be an Indian citizen / NRI.
• ERIs must fulfill the eligibility requirements as specified in the paragraph 9.1.4.1.

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 • Investments by foreign investors shall, however, be subject to guidelines as may
be specified by RBI and government of India from time to time.

Question 5: Are the Investment Conditions mentioned in the paragraph 9.1.6

enough to warn and guard investors regarding the risky nature of crowdfunding?
Specify changes, if any, along with the rationale.

9.2 Who can raise funds from Crowdfunding Platform and Limitations on capital
raised?
9.2.1 Crowdfunding is intended to solve the funding problems of early stage startups and
SMEs. The existing various sources of funding through capital markets for startups and
SMEs in India have been summarized in paragraph 7.

9.2.2 As crowdfunding shall entail substitution or relaxation of requirements of

prospectus or listing etc. various jurisdictions have imposed different set of limitations
on the amount allowed to be raised through online crowdfunding platforms and the
conditions to be satisfied by the issuing companies. Some of these are listed as under:

Jurisdiction Limitation on capital Raised

USA $1,000,000 in a period of 12 months

UK €2.5 million in a period of 12 months

New Zealand NZ$2 million from 20 investors in any 12 month period

Not more than $2 million or transfer equity to more than 20 people in a
Australia
12 month period

France €1m (£827,951) per campaign per year

Canada $1.5 million over one year

9.2.3 Some jurisdictions have also imposed restrictions on the nature of companies
which can raise capital from such crowdfunding platforms, e.g. in Italy crowdfunding is
restricted only to innovative startups. To be innovative a firm must be recognized as

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such by the Chamber of Commerce and to be startup a firm can be no more than 48
months in existence.

9.2.4 Crowdfunding can provide an alternative source of capital for startups and SMEs
that either have limited access to capital or have exhausted other available sources of
capital. It is, therefore, proposed that the additional channel of crowdfunding platform to
raise modest amount of funds is allowed to be accessed by early stage startup or SME
which is an unlisted public company incorporated in India, under EbC or DbC routes as
mentioned in paragraph 9.4, provided it is:

• a company intending to raise capital not exceeding Rs. 10 Crores in a period of 12

months. Companies which intend to make issue more than size of Rs.10 Crores may
raise funds by complying with the provisions of SEBI (ICDR) Regulations and list them
on a SME Platform or main board of a recognized stock exchange,
• a company which is not promoted, sponsored or related to an industrial group which has
a turnover in excess of Rs. 25 Crores or has an established business,
• a company which is not listed on any exchange,
• a company which is not more than 48 months old,
• a company which proposes to engage in non-financing ventures, i.e. funds raised
through the crowdfunding platform will not be further used for providing loans or
investments in other entities, and
• a company which is not engaged in real estate and activities which are not permitted
under industrial policy of Government of India.

9.2.5 Further, to ensure only genuine entities raise funds through this mode:
• The issuing company, its directors, promoters or associates have not been prohibited
from accessing or operating in the capital markets or restrained from buying, selling or
dealing in securities under any order or direction passed by the SEBI.
• The issuing company, its directors, promoters or associates are not mentioned as a
'defaulter' or a 'wilful defaulter' by RBI or CIBIL.
• The director(s) or promoter(s) are not disqualified to be appointed as director(s) under
the Companies Act 2013.

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 • The issuing company, its directors, promoters or associates are 'fit and proper' persons
as specified under the Schedule II of the SEBI (Intermediaries) Regulations, 2008.

9.2.6 In addition to above, the issuers must also comply with the following:

• In a given period of 12 months, Issuers shall not use multiple crowdfunding platforms to
raise funds.
• Issuers shall not directly or indirectly advertise their offering to public in general or solicit
investments from the public.
• Issuer shall compulsorily route all crowdfunding issues through a SEBI recognized
Crowdfunding Platform.
• Issuers shall not directly or indirectly incentivize or compensate any person to promote
its offering.
• Issuers shall provide provisions for oversubscription. This may include maximum
oversubscription amount to be retained, which should not exceed 25% of the actual
issue size; intended usage of the oversubscribed amount. The total amount retained.
including the actual issue size and oversubscription, shall not exceed the limit of Rs. 10
Crores.

Question 6: Given that the companies coming for crowdfunding lack any
significant track record, are the conditions and requirements mentioned in
paragraph 9.2 enough to fend off fraudulent issuers? Specify changes, if any,
along with the rationale.

9.3 Disclosure Requirements on Issuer

9.3.1 It is proposed that Crowdfunding follow a disclosure based regime. It is very
important that the companies seeking to raise funds through crowdfunding disclose true
and factual information to facilitate investors in an informed decision making. The
disclosures are required (i) when an issuer approaches the crowdfunding platform with
the intention of raising funds from the accredited investors registered with the platform,
and (ii) at regular intervals on an ongoing basis.

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9.3.2 Though different jurisdictions have specified different set of disclosures for the
issuers, the basic spirit behind this is to enable the investors to make an informed
decision regarding their investments and to keep a track of the growth of their
investments on a continuing basis. The disclosure requirements in different jurisdictions
are as follows:

Jurisdiction Required disclosures

• The name, legal status, physical address and Web site address of
the issuer;
• The names of the directors and officers (and any persons occupying
a similar status or performing a similar function), and each person
holding more than 20 percent of the shares of the issuer;
• a description of the business of the issuer and the anticipated
business plan of the issuer;
• a description of the financial condition of the issuer83;
• a description of the stated purpose and intended use of the proceeds
of the offering sought by the issuer with respect to the target offering
amount;
• statement on excess investment;
USA
• description on other offerings, related party transactions and
financial condition;
• the target offering amount, the deadline to reach the target offering
amount and regular updates regarding the progress of the issuer in
meeting the target offering amount;
• intermediary identification and compensation;
• the price to the public of the securities or the method for determining
the price; and
• a description of the ownership and capital structure of the issuer.
• In addition, Section 4A(b)(1)(I) specifies that the Commission may
require additional disclosures for the protection of investors and in
the public interest.

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 Investors should be presented with information that is "fair, clear and
UK not misleading" when deciding whether or not to make an investment.
No specific disclosures mandated by the regulator.
Issuers making Crowd Sourced Equity Funding(CSEF) offers through
New
licensed CSEF intermediaries will be exempt from the normal
Zealand
requirements to register a product disclosure document.
A document with information concerning the company, its activities and
France
its financial situation.
• Detailed business plan
• Disclosure of the issuer’s cash with third party confirmation if the
issuer has not incurred any expenditures and its only asset is cash;
or
• Annual financial statements if the issuer has incurred expenditures;
Canada
or
• Audited annual financial statements if the issuer has raised more
than $500,000 under the crowdfunding prospectus exemption or any
other prospectus exemption since its formation and has expended
more than $150,000 since that time.

9.3.3 Though the disclosures may not be as elaborate as IPO disclosures, which would
increase the cost of compliance, some basic details of the company need to be
provided. Therefore it is proposed that, a company intending to raise funds through
crowdfunding platform submit an Private Placement Offer Letter to the Crowdfunding
Portal, which inter alia may contain the following:

i. Name of the company & Registered office address

ii. A description of the current/new venture for which the funds are being raised
(Anticipated Business Plan)
iii. Issue Size and specified target offering amount and intended usage of funds
iv. A description on the valuation of securities offered
v. Past history of funding, if any
vi. History of any prior refusal from any Crowdfunding Platform

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 vii. A description of financial condition of the company including Audited financial
statements of 1 year, if any (Balance sheet, Profit and Loss Account, Cash Flow
Statements)
viii. Price of securities offered and the rights and liabilities attaching to the securities
ix. Ownership details and capital structure
x. Details regarding Board, Management and Group entities, persons with a
shareholding of 20% or more, etc.,
xi. Principal risks to the issuer's business
xii. Grievance redressal and Dispute resolution mechanism, such as arbitration
mechanism
xiii. Such other information as SEBI may specify

9.3.4 The Private Placement Offer Letter submitted by the issuer shall be circulated
online only to those selected accredited investors who are registered with the
crowdfunding platform and have made a commitment, not numbering more than 200,
and excluding QIBs.

Question 7: Are the disclosure requirements for a company interested in raising

funds through crowdfunding platform mentioned in paragraph 9.3.3, enough to
enable investors in an informed decision making ? Specify changes, if any, along
with the rationale.

9.3.5 Though future projections are not allowed in offer document of a public issue, but
in crowdfunding, owing to the lack of any meaningful business history or financial track
record, decision making is significantly based on the future projections made by the
issuer. So it becomes important that a realistic view into the future growth path of the
issuer is provided to the prospective investors. These projections should be based on
some trusted third party research and realistic assumptions.

Question 8: Due to the lack of history and track record, it is important that the
issuers provide future projections of their business to facilitate investors in

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 decision making. What should be the criteria to ensure that the projections are
realistic and achievable and not misguiding in nature?

9.3.6 The issuing companies shall also be required to submit information on an ongoing
basis. It is proposed that the issuing companies submit biannual disclosures to the
Crowdfunding Platform, which inter alia may contain the following:

i. Audited financial statements (Balance sheet, Profit & Loss statement, Cash flow
statement etc.)
ii. Utilization of funds raised in accordance to the object of the issue as specified at the
time of the issue
iii. A detailed view of the current state of business and the progress made since last
disclosure
iv. Any other funding raised since the last disclosure
v. Any penalty, pending litigation or regulatory action against the company or
promoter(s) or director(s)

9.3.7 Such ongoing disclosures shall be displayed by the platform on its website and will be
available to accredited investors who are registered with such platform.

Question 9: What should be the continuous disclosure requirements for a

company once it gets displayed on the platform? How it should be ensured that
there is no information asymmetry between various prospective investors?

9.4 Who can set up a Crowdfunding Platform?

9.4.1 It is necessary that crowdfunding platforms are not established or not used to
facilitate fund raising by fraudulent entities. It is therefore important to specify integrity,
experience and solvency requirements applicable to crowdfunding platform owner and
the key persons associated with it. Therefore it is proposed that any online offering or
issue or sale through the internet can be made only through a SEBI recognized
crowdfunding platform.

9.4.2 If it is intended to develop a framework for Crowdfunding Platform, the criteria for
eligibility or recognition need to be specified.

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9.4.3 The entities who can set up a crowdfunding platform or website and their roles and
responsibilities in different jurisdictions are as follows:

Jurisdiction Roles and Responsibilities of Crowdfunding Platform

USA If the online platform just lists an entrepreneur’s or company’s pitch, uses
a third party to manage the transfer of both cash and stock, and offers
general support services that don’t fall into these categories of activities,
it can register as a crowdfund investment portal. If it conducts any of
these activities, it must register as a full broker-dealer.
It has the following responsibilities:
• directors, officers or partners (or any person occupying a similar
status or performing a similar function) are prohibited from having
any financial interest in an issuer using its services
• required to take steps to reduce the risk of fraud by obtaining a
background and securities enforcement regulatory history check
on each officer, director, and person holding more than 20 percent
of the outstanding equity of every issuer whose securities are
offered by such intermediary
• Intermediary and its associated persons prohibited from accepting
an investment commitment unless the investor has opened an
account with the intermediary and the intermediary has obtained
from the investor consent to electronic delivery of materials
• Intermediary required to deliver to the investors educational
materials at the time of account opening
• Intermediary required to disclose its compensation structure to the
investor
• Intermediary required to make issuers' information available at
least 21 days prior to the issue
• Intermediary to ensure that an investor's investment limit is not
breached before it makes an investment
• Intermediary to provide communication channels on its website for

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 investors to connect amongst themselves as well as for an
investor to connect to an issuer
• Intermediary to ensure that all proceeds are only provided to the
issuer when the aggregate capital raised from all investors is
equal to or greater than a target offering amount, in case it is a
broker. In case of funding portal, since it cannot receive funds, it
would direct the funds to a qualified third party like bank, which
then makes the transfer to the issuer once the proceeds equal or
exceed the target amount
• Funding portals required to maintain a fidelity bond as a
contingency fund
Crowdfunding platforms will be able to make direct offers to retail clients
for a period of 12 months so long as the investor signs a Restricted
Investor Statement.
Crowdfunding platforms therefore need to ensure that they (a) include
the name of the firm; (b) provide accurate information on the firm and not
emphasize potential benefits of the investment without also giving a fair
UK
indication of the risks; (c) present the information in an easily
understandable way; and (d) not disguise or hide any important
statements or warnings.
The FCA does not prescribe the level of due diligence which needs to be
undertaken by crowdfunding platforms to assess the benefits and risks
involved with each particular investment.
• The provider has fair, orderly, and transparent systems and
procedures for providing the service:
• The service is designed primarily for offers by persons other than
New Zealand the provider and its associated persons:
• The provider has an adequate policy for identifying and managing
the risk of fraud by issuers using the service (the anti-fraud policy)
that, at a minimum—

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 (i) checks, against publicly available and readily accessible
information, the identity of the issuer and information
provided by the issuer relating to the identity and character
of its directors and senior managers; and
(ii) excludes an issuer from using the service if the
provider—
(A) is not satisfied as to the identity of the issuer or
of the issuer's directors and senior managers; or
(B) has reason to believe that any of the issuer's
directors or senior managers are not of good
character; or
(C)has reason to believe that the issuer is not likely
to comply with the obligations imposed on it under
the service
• The provider has adequate disclosure arrangements to give
investors, or to enable investors to readily obtain, timely and
understandable information to assist investors to decide whether
to acquire the shares (for example, through initial disclosure, or
question and answer forums, or other information that is made
available)
• The provider has an adequate policy (a fair dealing policy) for
excluding an issuer from using the service if the provider has
information (for example, from checks or assessments it carries
out (if any)) that gives it reason to believe that the issuer, in
relation to any dealing in shares using the service, has—
(i) engaged in conduct that is misleading or deceptive or
likely to mislead or deceive; or
(ii) made a false or misleading representation in
contravention of section 22 of the Act; or
(iii) made an unsubstantiated representation in
contravention of section 23 of the Act:

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 • The provider has adequate systems and procedures for
implementing the anti-fraud policy and the fair dealing policy:
• The provider has adequate systems and procedures for ensuring
that each issuer does not raise more than $2 million in any 12-
month period under the service:
• The provider has adequate systems and procedures for handling
conflicts between the commercial interests of the provider (or of its
associated persons) and the need for the provider to have fair,
orderly, and transparent systems and procedures for providing the
service.
• If a broking service is to be provided by the provider in the course
of providing the service, the provider is, or will be, registered under
the Financial Service Providers (Registration and Dispute
Resolution) Act 2008 for the broking service on and from
commencing to provide the broking service.
• The website operator needs to demonstrate that it has sufficient
resources (including financial, technological and human
resources) and adequate other arrangements (including
arrangements for handling of conflicts of interest involving the
licensee) to ensure that, to the extent that it is reasonably
Australia practicable to do so, the market a fair, orderly and transparent.
• In case, a CSEF (Crowd Sourced Equity Funding) website is
promoter of a company seeking funds through that website, it can
call for additional disclosures like details of any benefits to that
promoter.
• Advertising restrictions on the CSEF website.
They are supposed to provide the following services:
• Non-guaranteed placement
France
• Order receipt-transmission on behalf of third parties (ORT)
• Order execution on behalf of third parties

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 • Operation of a multilateral trading facility
• Investment advice
Portals must comply with general registrant requirements applicable to
EMDs (with certain exceptions), including minimum capital, insurance,
regulatory reporting, record-keeping and record-retention requirements.
Portals will be required to:
• conduct background checks on issuers, directors, officers,
promoters and control persons,
• understand the general structure, features and risks of a security
offered,

Canada • review the information presented by the issuer on the portal's

website to confirm that the information adequately sets out the
general features and structure of the security, issuer-specific risks,
parties involved, any identified conflicts of interest, and the
intended use of funds,
• deny access to an issuer if it has reason to believe that the issuer
or its offering is fraudulent, and
• provide investor education materials in plain language and obtain
a signed risk acknowledgement form from investors

9.4.4 Recognition of Crowdfunding Platform

9.4.4.1 It is proposed that the entities who fall in any of the following classes be allowed
to set up a crowdfunding platform.

9.4.4.2 Class I Entities:

• Recognized Stock Exchanges with nationwide terminal presence (RSEs)

• SEBI registered Depositories

9.4.4.3 In addition to the entities mentioned above, it is proposed that the another class of
entities with relevant experience and domain knowledge be allowed to launch

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crowdfunding platforms to ensure a healthy competition in the market, provided they
satisfy the requirements specified by SEBI.

9.4.4.4 Class II Entities:

• Technology Business Incubators(TBIs)

o promoted by Central Government or any State Government through
bodies such as NSTEDB (National Science & Technology
Entrepreneurship Development Board) under Department of Science &
Technology
o functioning as a society registered under societies act of 1860/or as a
non-profit making section 8 company,
o having at least 5 years of experience,
o having a minimum net worth of Rs. 10 Crores
o should have attained self-sufficiency and,
o should display only those companies which share a common focus thrust
areas as the TBI

9.4.4.5 A joint venture of a Class I entity and a Class II entity is also acceptable for
setting up a Crowdfunding Platform as this would bring the best of both classes.

Question 10: While Class I entities are already under SEBI's purview and have a
successful track record in securities market, Class II entities have a specialized
domain knowledge in the field of start up mentoring and funding. Is a joint
venture between the two classes a better idea than to allow them to launch their
own crowdfunding platforms separately?

Question 11: Any suggestions on some other possible entities which can be
included in Class II with a tentative list of qualifying criteria?

9.4.4.6 To enable Fund based Crowdfunding (FbC), it is proposed that the new class of
Crowd Fund AIFs be allowed to be displayed on the platforms launched by RSEs and
depositories. In addition to these platforms, a dedicated class of platform owners is

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proposed to enable FbC launching crowdfunding platforms provided they satisfy the
requirements specified by SEBI.

9.4.4.7 Class III Entities:

• Associations and Networks of PE or Angel Investors

o with a track record of a minimum of 3 years
o with a minimum member strength of 100 active members from the
relevant industry
o which are registered as Section 8 companies under Companies Act 2013
with a paid up share capital of Rs. 2 Crores

9.4.4.8 Thus the platforms launched by Class I & Class III Entities can enable the FbC.

Question 12: Any suggestions on some other possible candidates which can be
included in Class III for the purpose of providing platform for FbC? Also specify
their tentative qualifying criteria?

9.4.4.8 To prevent fraudulent offering of securities via the internet, it is proposed to

provide that no entity can raise funds through crowdfunding without channeling their
issues through a recognized Crowdfunding Platform, subject to the approval of
Screening Committee.

9.4.5 Requirements on Crowdfunding Platform:

Taking into consideration the risky nature of securities offered, the Crowdfunding
platforms must play the role of a gatekeeper and take reasonable measures to reduce
the risk of frauds. This requires adequate capital, technological and human resources to
carry out the business in a complying manner. Thus it is proposed that the obligations of
such platforms shall be as under:

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 • to conduct screening and basic due diligence of the business of the start up.
However, no amount of due diligence can provide any form of guarantee of
the commercial success.
• to conduct background and regulatory checks on the issuers, whole time
directors, promoters, shareholders holding more than 20% of equity shares in
the company
• review the information presented by the issuer on the portal's website to
confirm that the information adequately sets out the general features and
structure of the security, issuer-specific risks, parties involved, any identified
conflicts of interest, and the intended use of funds
• to conduct due diligence of investors such as net worth requirement and KYC
requirement, if any, while maintaining the privacy of the investors
• deny access to an issuer if it has reason to believe that the issuer or its
offering is fraudulent
• maintain a record of all the issues brought by the companies and
subsequently the disclosures of the issuing companies and make it easily
accessible to the investors
• collect and transmit information to SEBI as may be called for

Question 13: Any suggestions on some additional or reduced requirements on

Crowdfunding Platforms?

9.4.6 Further, to ensure a seamless operation and avoid any conflict of interest a
Crowdfunding Platform shall also be required to satisfy the following conditions:

• Platform needs to own the Domain ID/website/URL and mention the same in the
application for recognition with SEBI and should have adequate systems and
procedures to manage the daily operations as well as the emergency situations.
• Platform needs to have adequate human, technology and risk management
capabilities
• Platform needs to have fair, orderly and transparent processes
• Platform needs to have procedure to address possible conflicts which may arise
between issuers and the platform
• Fund raising by subsidiaries/associates or other entities related to the Platform
Owners shall not be allowed

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 • An elaborate contingency/termination plan need to be formulated with minimum
impact on the investors, to ensure a seamless operation in the event of closure
or financial distress in the crowdfunding platform
• Crowdfunding platforms shall not offer investment advice, solicit, manage funds
or securities, incentivize employees for such sale of securities displayed on the
platform or make recommendations to investors.
• Only accredited investors registered with a crowdfunding platform can invest
through that crowdfunding platform. Only Indian start-up companies or SMEs or
Crowd Funds can raise funds through these crowdfunding platforms.
• Platform shall provide a Grievance Redressal mechanism for the investors as
well as the issuers
• The task of due diligence of the issuing companies is very crucial to differentiate
a genuine issuer from a fraud. The due diligence, among other things, will involve
track record of the Promoters, Directors, Key Managerial Personnel, business
carried on by the company, proposed business plans, Opportunities, Strategies,
Litigations, etc.
• Apart from the basic due diligence, it is important that the platform puts in place
some sort of filtering mechanism to differentiate between the quality of ideas and
business plans. For this purpose, it is proposed that every crowdfunding platform
will have a 'Screening Committee' with a variety of experience from different
domains and sectors.

9.4.6.1 It is proposed that the Screening Committee of a Crowdfunding Platform may

have a strength of a minimum of 10 persons, which may have follow the following
composition:

• at least 40% of the committee should be composed of professional with expertise

in mentoring of startups and early stage ventures,
• at least 30% of the committee should be composed of professionals with
experience in banking or capital markets,

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 • not more than 30% of the committee should be composed of persons of high
caliber and qualifications which are nominated by the owner of the crowdfunding
portal, but not on its payrolls.

Question 14: Are the measures mentioned in paragraph 9.4.6 enough to ensure a
seamless operation of the Crowdfunding Platform and avoidance of any conflict
of interest? Suggest changes, if any, along with the rationale.

Question 15: Any suggestions on the role and responsibility of the screening
committee and its composition etc.?

9.4.7 Along with the companies raising fund by crowdfunding platform, the investors
also need to be subjected to a moderate level of due diligence. This is to make sure that
investors, particularly ERIs, are accredited and that they invest in accordance to the net
worth conditions specified by SEBI. The task of due diligence of investors in
crowdfunding could be given to the platform or some third parties which can be SEBI
registered intermediaries like brokers, depository participants (DP), Investment
Advisers, Portfolio Managers etc. ERIs and HNIs may be required to submit, among
other things, a net worth certificate from a Chartered Accountant to Stock Broker
/Investment Adviser/Portfolio Manager and also make a declaration or sign a 'Risk
Acknowledgement' regarding the understanding of risks in their investments.

9.4.8 Crowdfunding Platforms may charge a nominal fee from the company seeking
funds through the platform and the accredited investors looking for a good investment
opportunity in the companies which shall be displayed on the website only after a
comprehensive due diligence and screening.

Question 16: Given that only Accredited Investors may be allowed to invest
through Crowdfunding Platforms, it is important that their due diligence is
conducted properly to confirm their eligibility. Are the entities mentioned in
paragraph 9.4.4 capable in doing the same? Any suggestions in this regard?

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 Question 17: Making the platform's revenue directly dependent on the fee from
the issuers may lead to a conflict of interest. What could be the possible
alternative revenue mechanisms for the platforms which may eliminate or reduce
such conflicts?

Question 18: Should there be any restriction on the fee charged by a

crowdfunding platform to an issuer for getting access to the platform or an
accredited investor for registration or should this be left as a commercial decision
by the platform based on market forces?

9.5 Equity based Crowdfunding (EbC)

9.5.1 This route, as the name suggests, enables the issuers to raise upto Rs. 10 Crores
online by issuing equity shares through a recognized crowdfunding platform and offering
equity stake in their business to the accredited investors who are registered with the
platform.

9.5.2 A company desirous of raising funds by EbC route through a crowdfunding

platform may do so after it duly satisfies the due diligence and screening criteria set by
the platform.

9.5.3 These issues shall be further subject to the following conditions:

• No single investor shall hold more than 25% stake in a company.
• The promoter(s) shall be required to maintain a minimum of 5% equity stake in
the company for at least 3 years.

9.5.4 The issuers shall comply with the requirements specified in paragraph 9.2 and
follow the procedure as specified in paragraph 9.8. The Private Placement Offer Letter
will contain, inter alia, the disclosures as mentioned in paragraph 9.3.

9.5.5 The investors who invest in equity issues through EbC shall have rights of a equity
shareholder as given in the Companies Act.

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 Question 19: Any suggestions on the requirements in EbC to make it more
transparent and investor friendly?

9.6 Debt based Crowdfunding (DbC)

9.6.1 This route, as the name suggests, enables the issuers to raise upto Rs. 10 Crores
online by issuing debentures or debt securities through a recognized crowdfunding
platform to the accredited investors who are registered with the platform.

9.6.2 A company desirous of issuing debt securities by DbC route through a

crowdfunding platform may do so after it duly satisfies the due diligence and screening
criteria set by the platform and fulfills requirements as specified in paragraph 9.2.

9.6.3 These issues shall be further subject to the following conditions:

• The debt securities issued should comply with requirements specified under
Companies Act or rules made thereunder applicable to debentures or bonds.
• The issuer shall appoint a debenture trustee to hold the assets on behalf of the
investors.
• The issuer shall need to create a Debenture Redemption Reserve (DRR) of 25%
of the value of the debentures.

9.6.4 The issuers shall follow the procedure as specified in paragraph 9.8. The Private
Placement Offer Letter in DbC shall contain, inter alia, the disclosures as mentioned in
paragraph 9.3 and a summarized term sheet as specified in the SEBI (Issue and Listing
of Debt Securities) Regulations, 2008.

9.6.5 The debentures holders shall have rights as given under the Companies Act.

Question 20: Any suggestions on the requirements in DbC to make it more

transparent and investor friendly?

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 Question 21: Is there any need to prescribe the limit on the leverage a company
can take through DbC?

Question 22: Is there a need to change the rules regarding appointment of

Trustee and creation of Debenture Redemption Reserve in case of private
placement of debt with no intention of listing which seeks to issue debentures
through recognized crowdfunding platform?

9.7 Fund based Crowdfunding (FbC)

9.7.1 Under this route, the funds of the accredited investors registered with a recognized
platform will be collected online through the platform and pooled under the AIF to invest
in shares or debt securities in crowdfunded ventures which are displayed on a
recognized crowdfunding platform.

9.7.2 For this purpose, it is proposed to provide a separate class of funds under
Category I AIFs to offer Fund based Crowdfunding as Category I AIF- Crowd Funds.
The minimum and maximum corpus of such funds would be Rs. 10 Crores and Rs. 25
Crores respectively.

9.7.3 As per the SEBI (AIF) Regulations, 2012, such funds will be able to solicit funds
online from a maximum of 1,000 accredited investors. The requirement of the minimum
investment of Rs. 1 Crore by every investor for an AIF is also proposed to be relaxed for
this new class and brought to Rs. 25 Lacs. Under the proposal, funds can be solicited
online from upto 1,000 accredited investors registered with a platform by displaying
Crowd Funds on the crowdfunding platforms set up by class I or III entities as specified
in paragraph 9.4.4.

9.7.4 All the accredited investors viz. QIBs, Companies, HNIs and ERIs will be able to
invest in these funds. These pooled monies will be then invested by Crowd Fund AIFs
into start ups and SMEs displayed on a recognized crowdfunding platform under the
terms or objectives of the scheme. The sponsor or manager need to maintain a

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continuing interest of at least 2.5% of the corpus in the form of investment in the fund
and such interest shall not be through the waiver of management fees.

9.7.5 This new class of Category I AIF-Crowd Funds, can also solicit funds online
through crowdfunding platforms from the registered accredited investors, for deploying
them further into donation based crowdfunding. Thus Crowd Funds may also invest in
those companies displayed on the crowdfunding platforms which are incorporated as
not-for-profit entities or social enterprises set up as Section 8 companies under
Companies Act 2013, for charitable or community benefit or other public interest
projects, with investors focusing more on altruistic reasons or general benefits, rather
than any expectation of financial return to them.

9.7.6 Further for accepting donation from the registered accredited investors, the
minimum per capita investment can be set at Rs. 50,000. The grantor of donation shall
not be entitled to any dividend or profit or gain.

9.7.7 These Category I AIF Crowd Funds shall register with SEBI under the SEBI (AIF)
Regulations and the application shall be made in the format as specified in the First
Schedule to the said regulation under Form A. The disclosures in the Placement
Memorandum of the Crowd Funds shall be similar to Category I AIF- VCFs. The
ongoing disclosures and valuation requirements shall also be similar to the VCFs. The
disclosures are mainly related to disclosures on fees and charges, management of
conflicts of interest, investments and leverage, a prudent spread of risk and other
safeguards.

9.7.8 The Crowd Funds can, post registration with SEBI, get displayed on any
Crowdfunding Platform set up by either Class I or Class III entities, to raise funds from
a maximum of 1000 accredited investors (including QIBs, Companies, HNIs and ERIs)
registered with the platform through issue of placement memorandum. The Crowd
Funds may not be required to be subjected to the scrutiny of the Screening Committee
of the platform. The Crowd Funds can channel the funds raised from its investors

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through the platform into various companies which are displayed on the crowdfunding
platform. Units of such funds may be issued only in dematerialized form.

9.7.9 In contrast to EbC where the accredited investors directly hold equity of issues and
are shareholders of the company and therefore have legal ownership, in FbC the
investments of registered accredited investors are pooled and routed online through a
Crowd Fund. The fund holds the equity in its name on behalf of the investors who are
issued units of the fund rather than equity of the issuer, and thus have only beneficial
ownership in the equity of the company.

9.7.10 FbC addresses several regulatory issues like the restriction on the number of
offers made in private placement, minimum investment of Rs. 20,000 worth of face
value of securities by every investor etc. It also transfers the duty of investment decision
making from ERIs and HNIs, who are not well versed with different investment
strategies, to the fund managers, who are experts in this type of investment analysis.

9.7.11 The requirement on ERIs to be consulted by a SEBI registered Investment

Adviser or Portfolio Manager may not be applicable for investment through FbC.

Question 23: Any suggestions on the requirements in FbC to make it more

transparent and investor friendly?

9.8 Procedure for offering through a Crowdfunding Platform

9.8.1 There is restriction on public offering other than a prospectus based offer and
mandatory listing except for private placement of securities. Therefore it has been
proposed that the offer can be made through a web based recognized crowdfunding
platform only to accredited investors who have been given access to the platform.

9.8.2 A step-wise illustrative procedure is given as under:

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• An issuer, satisfying the requirements as specified in paragraph 9.2 and
interested in raising funds, gets displayed on a recognized crowdfunding platform
by submitting requisite documents and undergoing due diligence and screening
by the platform.
• The crowdfunding platform also maintains a list of accredited investors who have
been given access to the platform to invest in the companies displayed on it. The
accredited investors are allowed to register only after examination of KYC
compliances and fulfillment of other requirements like net worth, appropriateness
test, signing of Risk Acknowledgement etc. as mentioned in paragraph 9.1. Post
registration, these accredited investors are given a Login ID and password to
access the platform.
• Post screening by the Screening Committee of the crowdfunding platform, the
companies interested in raising funds through the platform can put up a notice
containing the brief of their business plan on the platform along with the funds
required.
• This notice will be subjected to an open discussion on a forum or public board,
like a chat room or chat board, provided by the platform, amongst the interested
accredited investors and the issuer in which the proposed business plan will be
analyzed and critiqued from different perspectives. This feature is provided to
gauge the interest of the accredited investors and support an informed decision
making by the prospective investors.
• The notice is intended to draw the attention of accredited investors registered
with the platform and not an invitation to subscription. After perusing the plan and
discussing it, the interested accredited investors can make a commitment or
pledge to the company about the funds they intend to invest.
• Once adequate demand is gauged, the issuer may make the formal offer for
subscription to those who have made commitment, not numbering more than 200
HNIs, ERIs and Companies collectively, and any number of QIBs, with the
detailed online Private Placement Offer Letter, which inter alia may contain the
disclosures mentioned in paragraph 9.7. This shall amount to an invitation or
offer for subscription and shall be in compliance with the Section 42 of the

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 Companies Act, 2013 and other rules and regulations pertaining to private
placement of securities.
• Pursuant to perusing the Private Placement Offer Letter, the accredited investors
may choose to invest in the company or may decide to withdraw their
commitment.
• The subscription amount shall be collected from the accredited investors who
choose to invest pursuant to perusal of Private Placement Offer Letter of the
issuer and kept in a separate bank account. The crowdfund platform owner or a
reputed designated third party shall open an escrow account with a Scheduled
Commercial Bank to hold the subscription funds of the investors.
• The issue shall remain open for a maximum period of 15 days.
• The crowdfunding issue will be considered successful only if it is able to achieve
a minimum pre-specified threshold, expressed in terms of percentage of original
issue size as mentioned in the Private Placement Offer Letter. This threshold
shall never fall below 50%. The subscription amount shall be transferred to the
issuer by the platform owner or the designated third party, only if the threshold is
achieved.
• The issuer shall allot the securities to the accredited investors who have
subscribed to the issue within 15 days from the date of receipt of the subscription
money. In case it fails to do so, it shall refund the entire sum to the subscribers
within 15 days from the date of completion of 15 days. In case the issuer fails to
refund the money within the aforesaid period, it shall be liable to refund that
money with interest at the rate of 12% per annum from the expiry of fifteenth day
of securities allotment.
• The issuer shall file a return with RoC as required under Companies Act 2013.
• In case of FbC, the procedure as mentioned in paragraph 9.7 and particularly in
9.7.8, shall be applicable.

Question 24: Any suggestion to simplify the procedure as specified in paragraph

9.8 within the existing legal framework?

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9.9 Secondary Market
9.9.1 Crowdfunding is intended to facilitate capital raising through online medium by
startups and SMEs and not for the resale of securities. There is no requirement of listing
for trading and no listing obligation on the issuer. Crowdfunding platforms only allow an
issuer to sell its own securities to raise capital and seldom provide a secondary market
for such securities. Therefore many jurisdictions have imposed restriction on a
secondary market of securities issued through crowdfunding.

9.9.2 However different jurisdictions have prescribed provisions for providing some exit
to the securities holders of crowdfunded ventures as given under:

Jurisdiction Provisions for Secondary Market

Securities issued in crowdfunding may not be transferred by the
purchaser for one year after the date of purchase, except when
transferred: (1) To the issuer of the securities; (2) to an accredited

USA investor; (3) as part of an offering registered with the Commission; or (4)
to a family member of the purchaser or the equivalent, or in connection
with certain events, including death or divorce of the purchaser, or other
similar circumstances, in the discretion of the Commission.
After purchasing unlisted equity in a company, even if it remains a
going-concern, investors will usually find there is no, or only a limited,
secondary market for their investments. Consumers investing in such
equity need to understand that they will probably have to wait until an
UK
event occurs, such as the sale of the company, a management buy-out
or a flotation, before getting a return. Consumers should realize that, in
the event of their death, ownership of these investments will probably
need to be transferred to their beneficiaries.
New This matter has not yet been clarified. Requested for public comments.
Zealand
Australia This matter has not yet been clarified. Requested for public comments.
• Securities of a reporting issuer are subject to a four-month hold period

Canada (subject to certain other conditions being met).

• Securities of a non-reporting issuer are subject to an indefinite hold

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 period and can only be resold under a prospectus exemption or under a
prospectus.

9.9.3 In the Indian scenario also, it is difficult to provide a secondary market trading
framework for the companies displayed on a crowdfunding platform, as then it would be
treated as a Stock Exchange. Hence, companies displayed on Crowdfunding Platforms
will not be treated as “Listed Companies” and there will be no secondary market liquidity
in such scrips and investors should be made aware about such risks before investing in
such companies.

9.9.4 The securities issued in crowdfunding by the issuer can be transferred by the
investors as under:

• to the issuer of the security in accordance with the provisions of Companies Act
2013 and the rules made thereunder, pertaining to the buyback of securities by
unlisted public limited companies,
• to another accredited investor registered with the platform,
• to a family member or relative or friend of the accredited investor or the
equivalent.

9.9.5 The promoter(s), however, shall be required to maintain a minimum of 5% equity

stake in the company for at least three years from the date of the issue.

9.9.6 The investor may get exit only when there is sale of the company, a management
buyout or a floatation of IPO or listing of company on a recognized stock exchange in
SME segment or main board.

9.9.7 If there is any shareholder agreement between promoters of the issuing company
and any AIF giving rights to such shareholders to sell their shares to the promoters etc.,
same shall be disclosed to all the accredited investors.

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 Question 25: Any suggestion on additional avenues of exit or liquidity of securities
in crowdfunding?

9.10 Protection from Cybercrimes

9.10.1 Crowdfunding Platform/Website is the center point of interaction between the
companies and the prospective investors. Moreover it will also function as the repository
of all the information and disclosures provided by the companies periodically. It
occupies a very crucial position in the entire infrastructure. Therefore it needs to be
secure and safe from all types of cyber-attacks.

9.10.2 To protect the Crowdfunding platform from hacking/identity theft, etc., the
necessary steps need to be taken by the owners of the Crowdfunding Platform.

9.10.3 To provide communication security over the Internet, the crowdfunding platforms
should be layered over Transport Layer Security (TLS)/ Secure Sockets Layer (SSL).
Platform owner should ensure safety, secrecy, integrity and retrievability of the data.
The platform owner shall have a adequate back-up, and Disaster management and
recovery and restoration plans.

9.10.4 It is desirable that platform owners draft a security policy which shall, then, be put
in public for comments and analysis. There shall be regular audits by reputed external
auditors who is CISA (Certified Information Systems Auditor) or otherwise appropriately
qualified that the security measures taken by the Platform Owners are adequate and
meet the requirements and that risk management systems are in place to identify and
mitigate the risks arising out of the regular operations.

Question 26: What kind of security features and IT Policies should be put in place
to make the crowdfunding platform safe and secure from all sorts of cyber
crimes?

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9.11 Tax Treatment
Taxation of funds raised through crowdfunding shall be in accordance with the current
tax provisions applicable to the unlisted companies raising funds through equity or debt
or an AIF.

Question 27: Crowdfunding is intended to perform the role of an alternate

funding option for entrepreneurs and investment option for investors in unlisted
companies or Crowd Funds. With this view, what kind of taxation treatment
would be suitable for the different stakeholders involved?

10.0 Role of SEBI

10.1 SEBI has been established with a triple mandate of protecting the investors'
interests along with developing and regulating the Indian securities market. These are
the guiding principles behind our policies and regulations. Therefore, to enable the small
issuers to raise funds and facilitate the investors in an informed decision making,
appropriate safeguards and disclosures are proposed to be put in place.

10.2 SEBI's role in crowdfunding, which is proposed to provide a cost effective and
efficient method of fund raising, will mainly be limited to:

• recognition of the Crowdfunding Portals

• oversight and regulation of the Crowdfunding market in India
• playing no role in vetting of the Private Placement Offer letter of the issuing
companies
• issuance of guidelines/circular regarding information required to be disclosed in
Private Placement Offer Letter or on an ongoing basis or requirements of due
diligence and screening or any other matter
• conduct of periodic inspections or audits of Crowdfunding Platforms and
enforcement of Crowdfunding Regulations

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11.0 Cost and Benefit Analysis of the Proposal
11.1 The proposed structure for crowdfunding will provide an enabling framework.
Crowdfunding may provide an alternative source of capital for entrepreneurs that either
have limited access to capital or have exhausted other available sources of capital. This
also saves the entrepreneur from a lot of effort required in obtaining capital and allows
him/her to focus on the business.

11.2 One of the objectives of the regulations is to reduce the costs involved in raising
funds for entrepreneurs. Under the existing regulations, an issuer is required to pay
underwriter fees, legal and accounting fees, registrar and transfer agent fees, merchant
banker fees, marketing & advertising fees or distribution commissions and other fees
some of which may not be applicable in crowdfunding.

11.3 Crowdfunding facilitates such entrepreneurs in raising funds without incurring too
much of the costs by doing away with the requirement of appointing a merchant
banker, marketing & advertising expenses and book building etc. Further, there shall be
no listing requirements and no prospectus needs be filed with SEBI. However, a
company seeking display in recognized crowdfunding platform may be required to pay
fees to such platform, which is expected to be substantially lower in comparison to the
current issue expenditure. The fees to a platform may be dependent on various factors
like number of platforms in the market, number of companies seeking display at such
crowdfunding platforms etc.

11.4 Crowdfunding not only helps the issuers to raise money but also serves as a way
of advertising for these companies. It helps in increasing their visibility which can
directly or indirectly lead to the growth in their businesses. Crowdfunding is expected to
spur entrepreneurship and benefit the entire economy.

11.5 Crowdfunding also enables investors to make relatively modest investments

across a range of opportunities with relatively low transaction costs and obtain equity
positions in companies that may eventually prove to be successful and profitable, which
they are not able to do under the current regulations. Platforms may also charge a
nominal fee to its registered accredited investors for carrying out their due diligence.

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Platforms may also be required to pay some fee for recognition. Consultation process
may assist in crystallizing such charges for the new framework.

12.0 Public comments:

12.1. Public comments and suggestions are solicited on the consultation paper. It does
not necessarily imply that all or any of the comments will be invariably accepted for
formulation of regulation. Interested persons may send their comments by e-mail to Mr.
Aditya Sarda (adityas@sebi.gov.in) or Mr. Ankit Goel (ankitg@sebi.gov.in) on or before
July 16, 2014.

12.2 Comments and suggestions should be given in the following format:

Name of Entity / Person / Intermediary

Question No./ Suggestion Proposal / Suggested
Rationale
on Paragraph No. Changes

Issued on: June 17, 2014.

***********

Disclaimer: References to various jurisdictions in this document have been based on the regulations/guidelines/consultation
papers, etc. of the respective country regulators and news articles/websites and other secondary sources. The references in no way
indicate validation of any country regulations on the subject. The purpose of the said references is only to provide the reader a
better picture of the global scenario with respect to crowdfunding. This paper should not be construed as a legal advice. Though
utmost care has been taken in the preparation of the paper, SEBI takes no responsibility for the accuracy or validity of the
information provided.

Page 64 of 66
 Annexure-1

Consolidated List of all Questions

Question
Question
No.
Given that Crowdfunding is still in nascent stages and most of the jurisdictions around the world have
Q1 taken a guarded view by allowing it in a restricted manner, do you think India is ready for crowdfunding or
is it premature to introduce such risky investment channel ?
Are the Accredited Investors mentioned in paragraph 9.1.4 suitable to participate in the risky investments
Q2 of crowdfunding? Is there a need to expand or reduce the categories of investors or expand or reduce
safeguards? Specify along with the rationale.
Are the Investment Limits specified in paragraph 9.1.5 justifiable with respect to the respective investor
Q3
classes? Are they too high or too low? Specify along with rationale.
Is the limit of investors upto 200 besides QIBs or employees of the company under a scheme of
employees stock option, as specified in Chapter III - The Companies (Prospectus and Allotment of
Q4
Securities) Rules, 2014, adequate or is there a need to amend such rules to allow upto 1,000 investors,
excluding QIBs or employees of the company under a scheme of employees stock option?
Are the Investment Conditions mentioned in the paragraph 9.1.6 enough to warn and guard investors
Q5
regarding the risky nature of crowdfunding? Specify changes, if any, along with the rationale.
Given that the companies coming for crowdfunding lack any significant track record, are the conditions
Q6 and requirements mentioned in paragraph 9.2 enough to fend off fraudulent issuers? Specify changes, if
any, along with the rationale.
Are the disclosure requirements for a company interested in raising funds through crowdfunding platform
Q7 mentioned in paragraph 9.3.3, enough to enable investors in an informed decision making ? Specify
changes, if any, along with the rationale.
Due to the lack of history and track record, it is important that the issuers provide future projections of
Q8 their business to facilitate investors in decision making. What should be the criteria to ensure that the
projections are realistic and achievable and not misguiding in nature?
What should be the continuous disclosure requirements for a company once it gets displayed on the
Q9 platform? How it should be ensured that there is no information asymmetry between various prospective
investors?
While Class I entities are already under SEBI's purview and have a successful track record in managing
issues and securities, Class II entities have a specialized domain knowledge in the field of start up
Q10
mentoring and funding. Is a joint venture between the two classes a better idea than to allow them to
launch their own crowdfunding platforms separately?
Any suggestions on some other possible entities which can be included in Class II with a tentative list of
Q11
qualifying criteria?

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 Any suggestions on some other possible entities which can be included in Class III for the purpose of
Q12
providing platform for FbC? Also specify their tentative qualifying criteria?
Q13 Any suggestions on some additional or reduced requirements on Crowdfunding Platforms?
Are the measures mentioned in paragraph 9.4.6 enough to ensure a seamless operation of the
Q14 Crowdfunding Platform and avoidance of any conflict of interest? Suggest changes, if any, along with the
rationale.
Q15 Any suggestions on the role and responsibility of the screening committee and its composition etc.?
Given that only Accredited Investors may be allowed to invest through Crowdfunding Platforms, it is
Q16 important that their due diligence is conducted properly to confirm their eligibility. Are the entities
mentioned in paragraph 9.4.4 capable in doing the same? Any suggestions in this regard?
Making the platform's revenue directly dependent on the fee from the issuers may lead to a conflict of
Q17 interest. What could be the possible alternative revenue mechanisms for the platforms which may
eliminate or reduce such conflicts?
Should there be any restriction on the fee charged by a crowdfunding platform to an issuer for getting
Q18 access to the platform or an accredited investor for registration or should this be left as a commercial
decision by the platform based on market forces?
Q19 Any suggestions on the requirements in EbC to make it more transparent and investor friendly?
Q20 Any suggestions on the requirements in DbC to make it more transparent and investor friendly?
Q21 Is there any need to prescribe the limit on the leverage a company can take through DbC?
Is there a need to change the rules regarding appointment of Trustee and creation of Debenture
Q22 Redemption Reserve in case of private placement of debt with no intention of listing which seeks to issue
debentures through recognized crowdfunding platform?
Q23 Any suggestions on the requirements in FbC to make it more transparent and investor friendly?
Any suggestion to simplify the procedure as specified in paragraph 9.8 within the existing legal
Q24
framework?
Q25 Any suggestion on additional avenues of exit or liquidity of securities in crowdfunding?
What kind of security features and IT Policies should be put in place to make the crowdfunding platform
Q26
safe and secure from all sorts of cyber crimes?
Crowdfunding is intended to perform the role of an alternate funding option for entrepreneurs and
Q27 investment option for investors in unlisted companies or Crowd Funds. With this view, what kind of
taxation treatment would be suitable for the different stakeholders involved?

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 FinTech in India | Ready for breakout

Contents
Foreword by IAMAI 04
Message by Deloitte 05
Introduction 06
Indian FinTech segments 09
Indian FinTech Scenario: To stay and to grow 11
Breakout of FinTech companies 13
Key factors leading to success of FinTech companies 13
Breakout FinTech Segments 14
Alternate Lending 16
Payments 22
Investment Management 27
Banktech 30
InsurTech 32
Personal Finance Management 33
Key challenges for Indian FinTech 34
Regulations: Balancing Act to foster innovation 34
Gain trust and improve perceptions through literacy 34
Financial Infrastructure and utilities 34
Cyber and Data security 34
Conclusion 35
Appendix 36
References 39
About IAMAI 40
About Deloitte 41
Acknowledgements 42

03
FinTech in India | Ready for breakout

Introduction
Technology has been a key enabler in
the growth of a digital economy. Over
the years, Indian banks and financial
services providers have gradually adopted
technology to improve reach, customer
service and operational effectiveness
with evolving market and technological
advances. However, the pace of technology
adoption has not been commensurate
with it's potential and hence there have
been gaps in the penetration of financial
services. For example, there is a credit
demand supply gap in the Micro and Small
Enterprise (MSE) segment particularly for
micro enterprises. We estimate the credit
gap in the MSE segment (with annual
revenue upto INR 3 crore) to be
INR 833,000 crores.

Exhibit 1: Credit gap in the MSE segment

Revenue Segment No. of Units Credit Demand Bank Credit Supply Credit Gap
(INR) (Mn) (INR 000 crore) (INR 000 crore) (INR 000 crore)

<15 Lakh 41.4 414 92 322

15 - 30 Lakh 5.6 168 62 106 Credit gap in the target

segment is
30 lakh - 1.5 Crore 4.5 477 203 274 INR 833k Crore or >60%
of credit demand of
1.5 Crore - 3 Crore 1.3 234 103 131 target segment

3 Crore - 18 Crore 1.8 720 357 363

Total 54.6 2013 817 1196

Note: Credit Demand is calculated based on revenue using appropriate multipliers

Source: Deloitte Analysis, MSME Annual Report, RBI, Industry Reports

06

Traditional Banks and Financial Institutions
have viewed technology as an enabler to
business propositions, rather than creating
new business propositions themselves.
Financial Technology (FinTech) Companies
however are changing that role by
leveraging digital technologies to create
new business propositions and target new
market segments which hitherto were not
possible.
FinTech in the truest sense is the
application of technology to offer new
financial products and services to new
market segments in an economically
Exhibit 2 FinTech – Convergence of Financial services and Technology
Bank
Payments
NBFC
Finance
Security Broking
Wealth Management
Distribution
Source: Deloitte Internal Analysis
Armed with advanced data and analytics
capabilities, asset light platforms and
almost zero processing costs, FinTech
companies are complementing, and in
some cases challenging the traditional
banking and financial services institutions.
FinTech in India | Ready for breakout
viable manner. From a business model
perspective, the FinTech sector is marked
by technology companies that either
intend to disintermediate, or partner with
incumbent Banks and Financial Institutions
depending on strategic narrative and
market landscape. Hence, FinTech is
increasingly becoming an important focus
area for all the key stakeholders in India’s
Financial Services industry – Regulators,
Traditional Banks, NBFCs, Payment Banks,
Investors, Payment Service Providers,
Broking and Wealth Management
Companies, Insurance providers and pure-
play FinTech players.
Hardware Providers
Software providers
FinTech Technology
Cloud providers
Platform providers
The immense potential of this sector is
clearly apparent in the global FinTech
funding scenario. With more than
$17 Bn funding and over 1400 deals in
2016, Fintech is one of the most promising
sectors globally. With nearly $270 Mn
funding in 2016, India is ranked amongst
the top ten FinTech markets globally.
07
FinTech in India | Ready for breakout

Exhibit 3 Global funding to FinTech sector in 2016

Netherlands
$20m Denmark
$32m Norway
Belgium $4m Sweden
Germany Russia
$28m $62m Czech India
$384m $7m
Republic $272m China
$6m
$7.7bn

Poland
$1m

U.K.
$783m
Ireland
Canada
$524m
$183m
Luxembourg
US $2m
France Japan
$6.2bn
$68m $87m

Mexico Switzerland
Taiwan
$72m $12m
$6m
Brazil
$161m Hong Kong
Spain Turkey $170m
$12m Indonesia
$17m
Italy Israel Thailand $5m
$9m $173m $19m Australia
$91m
Malaysia
Israel
$4m
$173m New Zealand
Singapore
$7m
$86m

South Africa
$15m

Globally, $17.4 Bn invested over 1,436 deals in 2016

≥ $500m ≥ $100m ≥ $10m < $10m

Source: PitchBook
Compiled by: Deloitte

In India, most of the FinTech companies
including the exponentially growing
m-wallets have been complementing
existing financial services providers, rather
than completely disintermediating them.
Traditionally, the Indian financial services
sector is characterized by brick and
mortar - branch banking, labor intensive
banking services, manual and paper based
processes with limited straight through
processing-despite continuous investments
in technology and systems by Indian Banks
and Financial Services Institutions. Hence,
there is a very high degree of customer
friction in the areas of customer on-
boarding, KYC and branch banking services.
This inefficiency in the system presents
an inherent opportunity for data-driven
analytics led FinTech business models in
reducing cost of acquiring and servicing
customers, eventually leading to a greater
penetration of financial services and
insurance products in the market.

1
http://www.livemint.com/Industry/QWzIOYEsfQJknXhC3HiuVI/Number-of-Internet-users-in-India-could-cross-450-million-by.html

08

Although Demonetization provided a boost
to the payments sector in the short term,
but we now expect investments in personal
finance and wealth management to rise
going forward.
There are a number of new business
models that are being introduced in urban
centers. There are a limited number of
players that are focused outside urban
and metro centers due to infrastructure
challenges (E.g. rural India has only
17% internet penetration compared to
60% in urban India)1. We believe that in
the medium term FinTech players will
consolidate their position in urban and
metro centers and will extend to rural and
semi-urban areas over the next 3-5 years.
The purpose of the paper is to analyze
the Indian FinTech Landscape, the likely
breakout of different FinTech segments in
the Indian context, their likelihood to scale,
and implications on the Indian Financial
Services and Insurance market.
Indian FinTech segments
In the Indian context, FinTech can be
broadly aligned across the following twenty
segments, across six broad financial
services areas. The twenty segments are
described in Exhibit 4. The contours of
these segments are broadly in line with
the findings of Deloitte global research
on “Future of Financial Services”, which
was jointly conducted along with World
Economic Forum and highlights the
emerging areas of innovations in the
financial services sector. As inferred in
the study, these innovations are also
clustered around specific areas with
unique underlying characteristics. FinTech
companies are leading the charge at
pioneering these innovations and are
continuously re-shaping the market
landscape, even in India.
FinTech in India | Ready for breakout
Within these segments, Digital Payments
have been at the forefront of leading
India’s FinTech sector. Correspondingly,
digital payments have also garnered the
lion’s share of VC funding as compared to
other segments. Post the Government's
demonetization initiative in November
2016, the spotlight on digital payments is
unique, as payments remain an innovation
cluster where penetration is extremely
low and there are still areas of friction that
new FinTech players can remediate to offer
value.
The retail lending segment, where there
is a convergence to the regulated regime
as most of the FinTech players in this area,
including P2P lenders, Alternative Credit
Scoring platforms and Crowd Sourcing
platforms, are eventually being brought
into the regulatory ambit. The MSME
lending area is witnessing new FinTech
players addressing the structural issues
of information asymmetry and reducing
turnaround times for underwriting loans to
small businesses.
Expectedly, the asset side of the banking
business remains a white space where
there have been limited innovations,
with the exception of Peer-to-peer
lending platforms.
09
FinTech in India | Ready for breakout

Exhibit 4

Areas FinTech Segments Brief Description

A. Credit 01. Peer-to-Peer Lending
02. Crowd Funding
03. Market Place for Loans
04. Online Lenders – on-book lending by
NBFCs
05. Credit Scoring Platforms
•• All forms of lending market places including Peer-to-Peer lenders
and market places that connect borrowers with both, institutional
and lenders;
•• Also includes crowd funding and equity funding platforms
•• NBFCs that use alternative scoring and digital channels for
acquisition

B. Payments 06. M-wallets and PPIs
07. Merchant Payments and PoS Services
08. International Remittance
09. Crypto Currencies
•• Services that enable transfer of funds for various use cases
- P2P (Person-to-Person), P2M (Person-to-Merchant), G2P
(Government-to-Person) etc.
•• Services targeted at both Payees and Merchants by enabling
requisite payment infrastructure through mobile or other
technologies

C. Investment 10. Robo Advisors •• Wealth advisory services delivered through technology governed
Management 11. Discount Brokers rules and investment strategies
12. Online Financial Advisors

D. P
 ersonal Finance 13. Tax Filling and Processing •• Tools and services for active management of individual financial
Management 14. Spend Management and Financial profiles (e.g. spend, investments, credit profile, etc.)
Planning
15. Credit Scoring Services

E. Bank tech 16. Big Data •• Services that utilize many data points such as financial
17. Blockchain transactions, spending patterns to build the risk profile of the
18. Customer Onboarding Platforms customer. This provides an alternate to traditional underwriting
methods that are unable to serve people with limited credit data.

•• There is significant value in unstructured data. However, it

is difficult to derive value from unstructured data, owing to
challenges in analyzing it. A number of new tools are being
developed to derive value from large data sets.

F. InsurTech 19. Insurance Aggregator •• Small business insurance

20. IOT, Wearables and Kinematics
•• Usage based insurance

Source: Deloitte Analysis

10

Indian FinTech Scenario:
To stay and to grow
India remains one of the largest markets
where the structural enablers to setup and
incubate FinTech companies have come
together strongly. The following seven
factors are likely to drive the growth of the
Indian FinTech sector, in the medium to
long term:
01. Combination of steady economic
growth with low penetration of
financial services: India’s GDP is
expected to grow at 6-8%2 for the
next decade, thus driving income and
consumption levels of households as
well as businesses. Coupled with low
penetration of household credit in tier
2 and 3 cities, mortgage, investment
and asset management services,
the banking and financial services
market is likely to grow at 2-2.5 times
of real GDP growth, thus sustaining
both incumbents and new FinTech
entrants. Further, improvement in
digital infrastructure (E.g. internet
and smartphone penetration) outside
urban and metro centres will drive
adoption of digital financial services.
02. Large public sector banks and
insurers lagging market growth:
On an aggregate basis, Public sector
banks and insurance firms are gradually
but continuously losing market
share to private banks and insurers
respectively, due to their inability to
outgrow the market. Notwithstanding
this steady loss, Public sector banks
still account for 70% market share of
deposits and credit. Going forward,
new private sector banks, including
new differentiated banks are likely
to be the beneficiaries of emerging
market opportunities. Along with the
2
World Bank Report
FinTech in India | Ready for breakout
differentiated banks, emerging FinTech
players in the areas of payments,
lending and investment management
will also benefit from low penetration
and focus on niche areas.
03. Regulatory forbearance toward
FinTech: Indian regulatory authorities
including RBI, SEBI and IRDA have
adopted an accommodative stance
toward an emerging FinTech sector,
without bringing in prohibitive
guidelines to overregulate the sector.
Despite catching up with the rapidly
evolving eco system, Indian regulators
have adopted a consultative approach
and have been proactively foreseeing
the need for adequate regulations,
especially in the areas concerning
public funds i.e. peer-to-peer lending,
crowd sourcing and alternative
currencies.
04. Indian Millennials rapidly
ascending the adoption S-curve
of digital financial services and
thus perceiving higher friction
from incumbents: With nearly 440
Mn Millennials, India has one of the
youngest populations that is becoming
productive and will drive consumption
and household savings. Moreover, this
age cohort is increasingly adopting
digital channels to initiate product
search, make inquiries, undertake
online fulfillment and finally, make
payments through digital channels.
This segment is likely to perceive
higher friction in the services offered,
particularly by public sector banks
and insurers, and hence, will gravitate
towards new platforms.
11
FinTech in India | Ready for breakout
05. India Stack and internet data
proliferation to improve financial
services utility infrastructure and
connectivity to support digital
financial services: India Stack is a set
of Application Programming Interfaces
(APIs) that allows FinTech companies,
developers and governments to utilize
India’s unique digital Infrastructure
towards presence-less, paperless,
and cashless financial service delivery.
Although India stack, powered by Jan
Dhan, Aadhaar & Mobile trinity, can
enable incumbent banks and financial
Exhibit 5 India Stack
Consent Layer
Cashless Layer
Paperless Layer
India Stack
Presence-less
Layer
Source: Credit Suisse reports, News articles, Deloitte analysis
06. Advances in technology and
adoption of cloud services leading
to asset light models with almost
zero unit costs at transaction
levels could enable subsidization
without building scale: A key barrier
to entry in traditional financial services.
FinTech companies will also pass on
the benefits of lower transaction
costs to end users, thus improving
their propositions. This aspect further
gets accentuated by the legacy free
environment in which most FinTech
companies operate, thus relying on
cloud based services to align their
overall cost structures.
12
service providers, but its true power
is harnessed by FinTech Companies
in significantly reducing costs of
acquisition and servicing. UPI can be a
game changer, as it has mass appeal,
owing to its universal acceptance and
security features. Aadhaar, which now
extends to ~1.1 Bn Indians can be levied
for effective biometric authentication of
financial transactions. It is proving to be
an optimal digital identity, and it gives
users the ability to securely utilize their
biometrics, when undertaking financial
transactions.
India Stack
Personal data store
Utilize power of data
IMPS, AEPS, APBS
Transition to cashless economy - new
and UPI
approaches to credential checking
Aadhaar e-KYC opening
Transactions performed in a paperless
bank account,
manner
e-sign, Digital Locker
Aadhaar Authentication
Unique digital biometric identity and
authentication from anywhere
07. Lower real interest rates in Indian
economy: With real interest rates
remaining low (OECD estimates, long
term interest rate forecasts of 6.8% pa,
2018), avenues to introduce new asset
classes through P2P platforms, low
cost money market funds, investment
management and robo advisory
services, are likely to gain acceptance
from urban and financially savvy
investors.
 FinTech in India | Ready for breakout

Breakout of FinTech
companies
Key factors leading to success of
FinTech companies
Out of the many FinTech players in India,
a small number of players will emerge as
winners, creating sustainable business
models that withstand the ups and downs
of economic cycles. These business models
will focus on retaining customer loyalty,
among evolving customer expectations;
strengthening IT infrastructure, in an
environment of exponential technology
advancements; using data-points to their
advantage; seeking appropriate funding;
lowering cost of operations; and offering
value-added offerings.

Exhibit 6 Key Factors leading to success of FinTech companies

Funding Environment
Availability of Funding through VC and PE firms is
imperative for FinTech companies to grow. In the past
three years Indian FinTech has witnessed more than
Customer Loyalty 120 deals worth $2.0 Bn.3
The most important element for FinTech
companies to concentrate on is customers.
They must find innovative and cost effective
ways to acquire and retain customer loyalty
Value Proposition
in an environment where the impediments
Most FinTech companies began by
to churn are lower. For e.g. gaining customer
focusing on segments where customers
trust, providing a seamless experience by
are most receptive. They understand the
reducing friction in digital transactions. Within
pain points of customers, and address
payments interoperability between players will
them to build a sustainable business
improve customer convenience.
that creates value. Across FinTech, three
segments i.e. Millennials (440 Mn), small
business, and underbanked, offer most
Technology & IT Infrastructure opportunities to FinTech businesses
Technology and IT infrastructure is
the foundation of FinTech. The FinTech
infrastructure backbone has been
strengthened tremendously with the host
of options available to market participants
such as BBPS, Bharat QR, India Stack, UPI.

Cost of Operations
Most FinTech companies have a cost
advantage over incumbents. They leverage
technology to
Innovative use of Data
•• Seamlessly on board, leading to lower
Big Data and analytics offer tremendous potential to customer acquisition cost
understand the needs of customer and offer personalized
•• Reduce servicing cost for customers
products & services and drive operational cost efficiencies
that give rise to altered business models •• Reduce cost of distribution
E.g. Payments Bank leverage technology to
expand customer base while limiting physical
Source: Deloitte Internal Analysis presence
3
CBINSIGHTS - The Global FinTech Report: 2016 in review

13
FinTech in India | Ready for breakout

Breakout FinTech Segments
All the segments of Indian FinTech have
started gaining ground albeit to different
extents, due to different underlying
characteristics that impact scalability,
adoption and viability. Moreover, not all
the segments are likely to breakout at the
same time. In order to assess the breakout
potential, as well as the timing of breakout,
Deloitte has developed a customized
FinTech breakout assessment framework
for the Indian FinTech market, drawing from
the learnings of the Future of Financial
Services study. For example, circa 2017,
the digital payments segment has clearly
witnessed a breakout due to a host of
business, market and extrinsic regulatory
reasons including a push towards digital
payments post demonetization. The digital
payments segment weighs positively
on most of the characteristics in the
framework. The framework qualitatively
grades the 20 FinTech segments across the
seven characteristics on three parameters
(High, Medium and Low) highlighted in
exhibit 7 below:

Exhibit 7

FinTech Breakout Characteristics Strategic Theme Addressed

01. FinTech companies that are addressing areas and functions where customer friction meets largest Creating new value propositions
profit pools (economic value)

02. FinTech companies that employ business models that are platform based, modular, data intensive, Designing new
and capital light to start with business model

03. FinTech companies that actively shape customer and user behaviors, thus resulting in long-term Shaping long term customer
structural change of the financial services industry behavior

04. FinTech providers that offer services to the underserved population, small and mid-sized Expanding market
businesses, using sophisticated capabilities on viable basis

05. FinTech companies that actively collaborate with Banks and other FIs and also operate within the Fostering collaboration and
regulatory purview or active consideration purview of regulators working within regulatory
purview

06. FinTech companies operating in segments with significant legacy issues and prevalence of Eliminating legacy constraints
conventional business models, that lack scalability

07. FinTech companies that target customers and make curated offers through Leveraging data and analytics
use of analytics and alternative / big data sources

Likelihood of Breakout
High Medium Low

The framework aims to address the
considerations across a range of business
aspects including scalability, business and
operating model alignment, addressing
new market opportunities, ability to
create and serve new market segments,
collaborating and partnering with banks.
Using the above framework, our team
analyzed various aspects of businesses
and consulted industry participants to
understand their breakout potential. Based
on the analysis of the 20 segments, the
results are summarized in exhibit 8 below.
The areas marked in darker shades indicate
a higher likelihood of breakout when
compared to other FinTech segments.
Based on the detailed analysis covered
subsequently, digital payments and
alternate lending emerge as the FinTech
segments with the stronger breakout
potential. A few of the segments including
crypto currency and InsurTech rank lower
in the Indian market context, though
globally these segments probably have
the same likelihood of breakout when
compared to a few segments that are rated
higher in the Indian context.

14
 FinTech in India | Ready for breakout

Exhibit 8 Indian FinTech Breakout Grid

Online Lenders -
Market Place NBFCs using own
Crowd for Loans capital Credit Scoring
Funding Platforms

Peer-to-Peer M-wallets and

Lending PPIs

Merchant
Payments and
PoS Services

International
w
or

vie
s
ion

Remittance
av i

ur
del

yp
eh
osit

mo

to r

s
rb

int
ul a

ic s
prop

ome
es s

a
re g

ly t
s t r
busin

na
et

hi n

on
v a l ue

cust

Mark

da
d w it

cy c
ta an
Shaping long term
Designing new
Creating new

b a nk s a n

Crypto
Expanding

Eli m i n a t i n g l e g a

Currencies
g d
h

n
i t

i
w

g
g

a
n

r
i

e
t
Co lla b o r a

L e v

Robo
Advisors

Discount
IOT and Brokers
Wearables

Insurance
Online Financial Advisors
aggregator
and aggregators

Customer Onboarding Tax Filling and

Platforms Processing
Blockchain Spend
Big Data Credit Management
Services and Financial
Planning

Likelihood of Breakout
High Medium Low

Source: Deloitte Analysis based on interaction with Industry participants

15
FinTech in India | Ready for breakout

Alternate Lending
Alternate lenders including P2P lenders,
marketplace platforms, digital lending
platforms are targeting specific credit
needs of retail consumers and micro
and small businesses that remained
underserved by banks and NBFCs, or
specific market segments including
e-merchants and other internet enabled
businesses.
The alternative lending business model is
built around technology that enables highly
efficient customer acquisition, approval and
servicing activities within a relatively light-
touch regulatory environment. Most Indian
banks’ and NBFC’s operating models,
in contrast, include physical branches
operating expenses, significant regulatory
overheads, collections and recoveries
functions that are needed to service an
aged loan book. Despite the low cost of
funds enjoyed by banks, these factors
add to the average cost of a loan. The
alternative lending model enjoys significant
operating cost advantage as compared to
the traditional banking and NBFC business
model.
Till now, most of the borrowers serviced
by alternative lenders tend to fall outside
the banks’ risk appetite, and segments
that value speed and convenience enough
to pay a premium (for example SMEs,
particularly in term loans, or high-risk retail
borrowers applying for personal loans).
In the medium to long term, emergence
of alternative lenders is likely to have an
impact on the NBFC’s business in India.
Unlike banks, most of NBFCs do not have
access to the low cost of funds, and with
higher acquisition and servicing costs,
NBFCs may be outcompeted as alternative
lenders gain traction in the Indian market.
The robustness of the credit algorithm of
FinTech players in this space is yet to be
tested as the industry is yet to complete a
full credit cycle. As the industry matures,
appropriate controls need to be put in
place to avert NPAs. Alternate lenders will
have to focus on keeping NPA percentages
lower than conventional banks. They must
not prioritize quantity over quality of loans.
This will ensure success of this model.

Exhibit 9 Alternative Lending Breakout Grid

Areas Fintech Creating Designing Shaping Expanding Fostering Eliminating Leveraging

Segments new value new long term market collabora- legacy data and
propositions business customer tion and constraints analytics
model behavior working
within
regulatory
purview

A. Credit 01. Peer-to-Peer

Lending

02. Crowd
Funding

03. Market Place

for Loans

04. Online
Lenders –
NBFCs using
own capital

05. Credit
Scoring
Platforms

Likelihood of Breakout High Medium Low

Source: Deloitte Analysis based on interaction with Industry participants

16

Within alternative lenders, peer-to-peer and households with surplus funds and
lenders and market place lending platforms savings who are seeking better returns. In
are likely to breakout faster, as these India, P2P lending through informal ways
lenders target profitable niches of Indian such as borrowing from family, friends,
borrower segments, pioneer new business and unorganized money lenders has
models by having only digital presence, traditionally been the primary source of
target underserved market segments, and capital for micro and small businesses, as
shape user behavior by gaining trust. well as individual borrowers meeting their
exigent financial requirements. Online P2P
Peer-to-Peer Lending platforms institutionalize and scale up
Peer-to-peer lending is an innovative this age old financing mode and act as a
model for transferring credit risk matching platform between borrower and
from banks and financial institutions, lender groups.
dispersing it among individual lenders.
These lenders are typically individuals
Exhibit 10 Reasons for using the services of market place lender – Borrowers and Lenders
Easy/quick application process
Fast decision-making
Convenience of online platform
Competitive rates
Repayment flexibility
Little documentation required
Trying out a new way of borrowing 39%
Less personal data required 35%
Couldn't get a loan / credit elsewere 30%
Recommendation from friend/colleague 22%
Distrust of banks 18%
Recommendation from banker/financial advisor 12%
Better return on Investment
Trying out a new way of lending/investing
Easy/simple to use
Convenient
Ability to specify risk aversion/return
Ability to choose who to lend to 36%
More secure 35%
Provision fund 35%
Quick return on investment 30%
Recommendation from friend/colleague 24%
Tax benefits 12%
Recommendation from banker/financial advisor 11%
Source: Deloitte UK Analysis
FinTech in India | Ready for breakout
Online P2P platforms significantly address
the key areas of customer friction. Based
on Deloitte research, P2P platforms have
been able to attract borrowers mainly
due to an easy supplication process and
quicker turnaround times. Moreover, the
convenience offered by these platforms
is valued by borrowers and as inferred
from borrower responses, interest rates
are not the sole criteria for borrowers.
However as expected, financial returns
(from lending) remain the top most reason
why individual lenders use P2P platforms,
along with seeking diversification in
investment avenues.
81%
72%
72%
69%
55%
53%
77%
71%
68%
62%
56%
17
FinTech in India | Ready for breakout

The Indian P2P lending segment is evolving
rapidly as new entrants play the role of
market makers and industry champions.
Most of the P2P platforms currently focus
on unsecured loans (Personal loans and
Microfinance) and the MSME segment,
by targeting borrowers that remain
underserved by Banks and NBFCs.
Two different business models have
emerged in the P2P lending segment.
Currently players have adopted either the
‘direct disbursal model’ or the ‘partner
assisted disbursal model’.
01. Direct disbursal model – The P2P
platform directly matches the
requirements of borrowers and lenders
and is similar to global P2P platforms.
Its current focus is on the personal
loans segment for urban, educated
and middle class customers, who
understand the marketplace model
and transact online. A few of the large
P2P platforms have started to maintain
nodal / escrow accounts for better
monitoring and control. This allows
both borrowers and lenders to deposit
funds in an escrow account held by the
P2P platform, and both disbursements
and repayments are routed through
these escrow accounts.
02. Partner assisted disbursal model – In
this model P2P platforms tie-up with
a field partner (local NGO or Micro
Financer) to manage customer
acquisition, disbursement, and
collections for a fee. The P2P platform
is primarily responsible for onboarding
lenders and offering matching services.
This model is focused on unsecured
loans (micro-finance) to low income
households ranging from $100-500.

Exhibit 11 P2P – Business Models in India

Two business models emerging in India

Direct Partner Assisted

Disbursal Model Disbursal Model

Direct Loan Disbursal

Money Loan
transferred disbursal

Online Field
Lender Borrower Lender Borrower
Platform Partner

Repayment Repayment

Lender and borrower matching

Online
Repayment Platform

Platform collects one time fee from lender and Lender and borrower matching
commission charges on loan value from borrower

18
 FinTech in India | Ready for breakout

Exhibit 12 P2P – Business Models in India

Model 1: Direct Disbursal Model 2: Partner Disbursal

Low Risk Medium Risk Rural Lending

Lender 11.5 - 16% 14.5 – 17% 8.0 – 10.0%
Return

Net Platform
Operating 1.5 – 2.0% 4.0 – 4.5 % 0.5 – 1.0%
Cost
Total Revenues: Total Revenues: Total Revenues:
2.5 – 3.5% 5.5 – 6.5% 1.5 – 3.0%
Platform
1.0 – 1.5% 1.5– 2.0% 1.0 – 2.0%
Margin

Partner MFI
Partner
9.0 – 10.0%
Commission

Interest rate
available to 15.0– 19.5% 20.0– 24.0% 19.0 – 23.0%
borrower

Source: Deloitte analysis and data based on interviews with P2P lenders.

Note - Net Cost of Operations includes verification and documentation costs, collection costs, marketing costs and staff expenses netted with one time registration
fee. In the partner model, the partner would incur the costs of customer acquisition, collections, customer relationship management.

As observed, in most of the borrowing RBI had already released a consultation

cases, P2P platforms are increasingly paper in April 2016, where it had taken an
offering competitive interest rates to approach to create a separate category for
borrowers along with extending significant the P2P lending business within the NBFC
premium to lenders, owing to very low segment. The final guidelines are expected
platform operating costs (1-2% of the loan to provide regulatory clarity on most of the
value administered). Considering that P2P critical business and operational issues.
platforms offer new investment avenues This would not only facilitate infusion of
and prospects of significantly higher new capital in the existing P2P platforms,
financial returns, the supply side factors but also attract new entrants in this
could exponentially drive the growth of this segment.
segment, as it attracts return conscious
lenders, and as these platforms gain trust
amongst investors, as well as, build strong
underwriting, credit risk management and,
fraud management capabilities. Developing
very rigorous risk management procedures
will lay a strong foundation required not
only to gain the trust of lenders, but also to
meet regulatory scrutiny.

19
FinTech in India | Ready for breakout

Summary of business and operational requirements that RBI can consider while
formulating the final guidelines

•• In-line with the loan aggregator's guidelines, P2P can also be regulated through a new “Differentiated NBFC” structure with minimum
capital requirement of INR 2 crore4.

•• Capital requirement for P2P can be linked with the overall outstanding loans facilitated through the platform in a way that provides
some factor of safety to borrowers– This can be in the form of Lender Security Reserve, where a certain portion of fees earned is
earmarked as a reserve to compensate for loss suffered, in case the loan defaults.

•• With direct transfers from lenders to borrowers, P2P platforms have limited ability to control disbursements and repayments. P2P
lenders can be permitted to setup a Nodal escrow account. Fund transfer between borrowers and lenders can flow through the
Nodal escrow account for operational efficiency, better monitoring, risk management, as well as enhanced experience for platform
users.

•• P2P lenders must have a transparent reporting mechanism – with a number of borrowers and lenders, cases open, total funds
disbursed, delinquencies /defaults etc. All this information must be filed with regulators and be available on the website for all the
borrowers. Any adverse change must be brought to the attention of users (both lenders and borrowers).

•• P2P must submit the loan data to Credit Information Companies (CICs) – for both, borrowers and lenders. Any defaults must be
reported in line with the CIC requirements.

•• Individual lenders must be permitted to do ECS on borrowers i.e. failure to repay automatically results in default.

•• Lenders must be asked to undertake a brief refresher course (set of scenarios that can rendered through online modes) to help
them understand the risks, and take cognizance that they may lose their capital, and that there is no recourse for capital protection.

•• RBI can consider allowing lending from NRIs if it will be done through NRO accounts.

•• Secondary trading of loans (through the existing securitization framework) can also be considered. Due inputs from SEBI can be
taken to ensure regulatory alignment.

Note - The above mentioned business and operational requirements were prepared basis discussion with Industry participants

Market Place Lending (MPL)
Market Place lending can be considered
as an extension of P2P lending, for both
business and individual loans, including
secured loans mortgages. Moreover,
market place lenders typically tend
to connect individual borrowers with
institutionalized lenders, including banks
and NBFCs. Globally, MPLs have gradually
transitioned to the model where most
of the loans are funded by financial
institutions and not by individual lenders.
In India, most of the MPLs have agency
arrangements with banks and NBCFs, and
primarily play the role of loan originators.
The responsibility of servicing and
collections is with the institutional lenders.
Another aspect which is strikingly different
in the Indian context is that MPLs don’t
transfer these loans on their books for
servicing, and hence do not securitize
these loans. Indian MPLs only offer
origination and perform credit assessment
and credit scoring services, with actual
underwriting being done by a partner bank
or NBFC. The only exception to this is in the
case of NBFCs that use alternative credit
scoring and use digital channels to acquire
and service borrowers, but fund the loan
themselves.
Three unique MPL models are currently
prevalent in India, depending the nature of
services provided by these platforms.
01. MPL Platform as Originator - Acts as
an aggregation and origination platform
to route leads to partner banks and
NBFCs
02. MPL Platform to route to NBFC
- Acts as an origination platform
between borrowers and in-house NBFC
03. MPL Platform as matchmaker
- Connects lenders and borrowers
enlisted based on loan requirements
with no / limited role in loan
disbursements and repayments
Notwithstanding the difference in
business models, in order to target new
borrower segments, MPLs assess the
creditworthiness of borrowers based
on metrics beyond the credit scores
and metrics used by banks and NBFCs
(e.g., banking transaction history, asset
ownerships, spend analysis, reference
checks from suppliers, customers, peer
business groups). Most MPLs are also
likely to refine their risk engine more
frequently than banks to incorporate
feedback based on empirical analysis
and market scenarios. Typically,
borrowers who can't have banks
service their requirements, are
targeted.

4
https://rbidocs.rbi.org.in/rdocs/content/pdfs/CPERR280416.pdf

20
 FinTech in India | Ready for breakout

Exhibit 13 Marketplace lending models in India

Type 1 Type 2 Type 3

(Platform as Originator) (Platform to route to NBFC) (Platform as match-maker)

•• Act as an aggregation and
origination platform to route
leads to partner banks and NBFCs
Role of
platform
•• Act as an origination platform
between borrowers and in-house
NBFCs
•• Also, plays the role of originator
for other banks and NBFCs
depending on the risk profile and
nature of loans
•• Has both, lenders and borrowers
enlisted on a common matching
platform
•• Connects the borrowers and
lenders with no/limited role
in loan disbursements and
repayments

•• Falls under the purview of •• There could be perceived •• Will fall under the proposed P2P
Account Aggregators conflict as platform is acting guidelines of RBI
Guidelines of RBI both as an aggregator and also as
Regulatory
an NBFC, funding loans
considerations •• Business scope limited to
generating loan applications for
partner banks and NBFCs. Funding
of loans by NBFCs not applicable.

•• Low - Though RBI guidelines •• High - Funding the loans •• Medium - Capital buffer may be
mandate a leverage ratio of 7 extended will block the funds required in the form of lender
times, the platform cannot fund of in-house NBFC's and strain protection reserve
the loan by itself, so capital buffer their capital
Capital not required to scale-up
•• No capital strain on platform
Intensity
•• No liability in case of any loan
defaults

policybazaar.com Capital Float ZOPA

Examples
bankbazaar.com LoanMeet.com

Source: Deloitte Internal Analysis

With low Retail and SME credit penetration
in India, MPL offers an alternative financing
avenue for both individual and MSME
borrowers. Due to their reliance on multiple
data sources, besides financials statements
/ income proofs, MPLs also address the
structural issues of information asymmetry
faced by Banks and institutional lenders.
P2P and Market Place lending segments are
the most promising breakout candidates in
the Alternate Lending segment. Supported
by regulatory clarity and a clear focus on
customer needs, the Indian alternative
lending space is likely to be a North Star for
banks to improve their underwriting and
risk assessment capabilities, along with
developing customer centric origination
and servicing processes.
In the Indian context, both banks and
alternate lending platforms will continue
to co-exist and serve different segments
in the market. FinTech is not likely to
disintermediate banks, and will rather
grow by partnering with the incumbent
financial institutions to develop extended
ecosystems. Banks in turn, will improve
their underwriting and servicing
capabilities, digital channels and back-office
automation.
In addition to P2P Lending and Market
Place lending, a few FinTech companies
also offer credit risk assessment and
underwriting as a service to banks and
NBFCs. For instance, Credit Mantri5 is
a platform that uses a combination of
traditional data (such as credit reports),
alternative data (such as social media),
and data from mobile phones, to create
a credit profile for customers. This profile
helps customers understand their credit
potential and enables them to make
informed credit decisions. Subsequently, it
also serves as a conduit, connecting these
customers to potential lenders based on
this score.

5
https://www.creditmantri.com/
https://www.crunchbase.com/organization/creditmantri#/entity

21
FinTech in India | Ready for breakout

Payments
Digital payments in India are undergoing
a revolution. A combination of factors
are disrupting the payments landscape,
as India, in the black swan event of
“demonetization”, transitions to a ‘less cash
society’. Payments infrastructure in India
has significantly evolved in the past 12-18
months, with new payments modes and
interfaces including UPI, BHIM and Bharat
QR Code being introduced to drive digital
transactions. Driven by this regulatory
push, and supply side interventions,
digital transactions have grown by leaps
and bounds. Post demonetization, digital
transactions have increased by 100%,
with PPI (primarily m-wallets) transactions
accounting for a lion’s share of this growth.
Average monthly digital transactions
have crossed a Billion transactions in
2017. Excluding NEFT transactions, PPI
transactions contribute nearly a quarter in
digital retail transactions. Average monthly
PPI transactions have grown more than five
times in the past year.

Exhibit 14 Growth in digital payments

Monthly volume of digital transaction in Mn

1600 Almost 5 times 100% growth

increase in in digital
1400 volume of PPI transactions
transactions post Nov’16
1200

1000
15% growth in debit card transactions
800 post Nov’16

600 Baseline 800 million average monthly

Debit card Transactions
400

200

0
Feb, 2016 Feb, 2017 Mar, 2016 Mar, 2017 Apr, 2016 Apr, 2017

Debit Card IMPS PPIs

Source: RBI Database

22
 FinTech in India | Ready for breakout

100% growth in digital transactions post
demonetization, resulted in India’s cash
to GDP ratio coming down to single digits
from the pre demonetization figure of
10.6%6. Given how digital payments were
inundated with excess demand post
demonetization, and customers learnt
to transact digitally (a major factor in
influencing adoption of digital transactions),
one would expect the digital rally to
continue. This was not the case. As the
economy moved to normalization, usage
of digital payments dropped, reflecting the
customer's preference for cash.
An impact assessment of new interfaces
and payments modes introduced in
India on broader payments FinTech
companies yields an optimistic scenario
for Payments focused FinTech companies.
Few payments FinTech companies are
leveraging these developments to pivot
their business models and change their
focus from consumer payments to
enabling banks, merchants, and other
payment intermediaries. Moreover, all
of these newly introduced instruments,
channels, and interfaces do offer a better
and effective payments architecture, but
still are mere enablers to the payments
business. None of these in themselves are
likely to create new business propositions
– something payments FinTech companies
aspire and aim for. Indian payments
FinTech companies are likely to thrive in
the backdrop of rapidly expanding digital
issuance of multiple issuance instruments
– Debit card, virtual debit cards, NFCs,
Bharat QR, wallets, as well as extremely
low penetration of acquiring infrastructure.
Payment FinTech companies are creating
new use cases for merchants and users,
and strengthening their value propositions.

Exhibit 15 Impact assessment on Payments FinTech

Interface / Modes Description Impact on Payments Fintech

UPI 2.0 Unified inter-bank consumer payment system with limited Neutral
$
information required to push transactions (wallets likely to be
included as per RBI announcements)

Bharat Bill Payment Bill presentment and payment system accessible through multiple Marginal due to increased
System channels, enabling multiple payment modes, and providing instant competition
confirmation of payment

Contactless cards Payments for small purchases by tapping a card with no signature, Favorable for Merchant
or PIN verification required PoS

BHIM -Bharat BHIM is a free app based interface for pushing payment Enables banks to improve
Interface for transactions using UPI. Users can make bank-to-bank payments, functionalities
Money pay and collect money using just a mobile number, or a Virtual
Payment Address (VPA)

Cloud Based POS Cheap, flexible and convenient software that enables merchants to Favorable for Merchant
sell products and access all customer data, online PoS

USSD Facilitate financial and non-financial transactions from any phone Neutral
available in 12 regional languages

Adhaar Enabled Unique digital biometric identity and authentication can be used Favorable for Merchant
Payments from anywhere to check credentials PoS

Bharat QR Code Common QR code jointly developed by all the four major card Enables banks to improve
networks—NPCI, MasterCard, Visa, and American Express functionalities

Breakout assessment of Payments for adoption, scaling-up and brand recall.

FinTech
Not coincidentally, M-wallets and PPIs
remain one of the preferred breakout
candidates and in the last one year this
segment has definitely outgrown other
segments in terms of breaking boundaries
However, there are emerging headwinds
including tighter regulatory stipulations
going forward that could slow the
momentum of M-wallets in particular.

6
https://www2.deloitte.com/content/dam/Deloitte/in/Documents/tax/budget2017/in-tax-budget-impact-fs-noexp.pdf

23
FinTech in India | Ready for breakout

Exhibit 16 Payment FinTech breakout Grid

Areas Fintech Creating Designing Shaping Expanding Fostering Eliminating Leveraging

Segments new value new long term market collabora- legacy data and
propositions business customer tion and constraints analytics
model behavior working
within
regulatory
purview
B. 01. M-wallets
Pay- and PPIs
ments
02. Merchant
Payments
and PoS
Services

03. International
Remittance

04. Crypto
Currencies

Likelihood of Breakout High Medium Low

Source: Deloitte Analysis based on interaction with Industry participants

The proposed new PPI guidelines are likely
to mandate a full KYC requirement post
60 days of activation. This change may
discourage both merchant, and users to
adopt wallets for small value payments. At
the same time, the proposed roadmap for
wallet and PPI interoperability will provide
a great impetus for merchant adoption, for
acquiring wallet transactions. Moreover,
wallets are currently not included in the
UPI architecture, and banks may get some
heads up to catchup with wallets. However,
the recent announcement from the RBI to
include wallets in UPI via interoperability,
will clear clouds of doubt on the efficacy of
their business model. Interoperability will
increase competition amongst wallets to
retain their customer base (as switching
cost for customers decreases), pushing
wallets to provide better services and
customer experience. It will also drive up
transaction volumes, as the same set of
customers and merchants need not be
acquired/ targeted by each wallet. Wallets
are likely to add new merchant categories,
such as government payments, public
transportation, toll, parking and other
social payments, and also increase use-
cases to increase overall engagement levels
with users.
Payments FinTech companies, including
wallets and PoS solutions providers, are
also working towards integrating credit
offerings, by analyzing the transaction
history of users. Most of the large wallets
players are working with NBFCs and banks
to offer small value loans to their users.
These loans can also be used to effect
purchase in case of shortfall in funds in the
wallet. By leveraging transaction history
and developing spend patterns, wallets are
effectively able to generate a proprietary
credit scope, which can be used to offer
loans by partner banks and NBFCs.

24
 FinTech in India | Ready for breakout

Exhibit 17 Integrated Payments and Credit Operating model

Credit underwriting and servicing using wallets/PPI

1 2 3 4
Customer Assessment Loan Disbursal on Pre-paid card usage Customer
and Onboarding Prepaid Card through partnerships Data Analytics

Agent Customer Agent Customer

•• Agent meets customer
to understand loan
requirement and explains
product features and T&C
•• Performs customer
assessment and KYC
•• Loan application is
approved
•• Loan amount is loaded on a
wallet/pre-paid card
•• Wallet/pre-paid card can be •• Transaction history for
used at merchant outlets customer analytics for
cross sell and credit
assessment

Wave 1: Operational Efficiency Realization Wave 2: Customer Digital Foot Print building

Operational efficiency enhancement

Improved Underwriting

Opportunities for cross sell/ upsell

Personalized interactions

Source: Deloitte analysis based on discussion with NBCFs and wallets

Notwithstanding the innovations that have
emerged, enabled by cheaper processing
and data capabilities, and all the time
connected users, most FinTech companies
in the payments segment are likely to focus
on improving front end interfaces and
processes to enhance user experience.
The payments sector in India has relatively
low barriers to entry compared to other
financial services, and perhaps, that could
be one of the reasons for the fast pace of
innovations in this segment. Going forward,
partnerships with large merchants and an
unerring focus to drive the unit transaction
cost to near zero, will be the two decisive
factors for payment FinTech companies.
Cypto currency and cross border
payments.
Despite the global spotlight, crypto
currencies including bitcoins had a slow
start in the Indian market. Not only could
this be due to the regulatory decree on the
use of cryptocurrencies, but also due to the
lack of clear understanding of the potential
applications of the underlying blockchain
technology. In the past 2-3 years, few
Indian FinTech players have setup bitcoin
exchanges in India to facilitate the purchase
and use of bitcoin as an alternate currency
for paying for mobile credit, data card
and DTH bills. Global block chain startups
including Ripple have partnered with
Indian FinTech Companies to offer their
proprietary blockchain enabled currency –
XRP. Ripple uses the same currency (XRP)
to undertake international remittance
business by setting up exchanges in
host markets. Unlike other popular
cryptocurrencies, XRP is a pre-mined
currency used for settlement and it has the
advantage of increased settlement speed
over other cryptocurrencies.

25
FinTech in India | Ready for breakout

In India demand for bitcoins increased post
demonetization, with one daily7 quoting
demand of bitcoins to be INR 40-50 Cr daily
as of April 2017. In recent months increased
demand of bitcoins has increased its value
exponentially, from INR 1,10,000 per bitcoin
as of May 2017 to INR 1,90,000 by June
2017, with India accounting for 16,754.76
bitcoins by trade volume8. The use case
of international remittance for blockchain
technology is one of the promising use
cases for the Indian market. India is the
biggest market for remittances, with
over $62 Bn9 sent to India from abroad
in 2016. With low cost and real time
transfers, blockchain currencies such as
XRP, Ethereum, Bitcoin etc. can transform
India’s cross border payments business
and offer real benefits to customers, banks
and regulators, subject to adequate trust,
credibility and regulatory acceptance. More
importantly, these transactions will also
have to meet the AML and KYC standards,
to ensure genuine transactions.
The likely benefits of using blockchain
in enabling cross border payments are
described in the illustration below:

Exhibit 18 Blockchain - Benefits under cross border payments

Initiate relationship Transfer money Deliver funds Act post payment

7
Sender ID Transfer amount
1 Beneficiary Date and time
ID FX rate Payout conditions
Verify KYC 6 Distributed On-demand
Sender Beneficiary ledger reports
Transfer bank Fiat currency Fiat currency bank Verify KYC
request
4 5 Pay funds
Sender Submit Beneficiary
transfer Smart contract

Money 3 Real-time AML Money

transfer transfer
2
operator operator

Regulator Regulator

01. Seamless KYC: leveraging the digital profile stored on the decentralized ledger establishes trust and authenticates the sender
02. FX liquidity capabilities: through smart contracts, foreign exchange can be sourced from participants willing to facilitate the
conversion of fiat currencies
03. Real-time AML: regulators will have access to transaction data, and can receive specific alerts based on predefined conditions
04. Reduced settlement time: cross-border payments can be completed in real time
05. Cost savings: with fewer participants, the improved cost structure can generate value
06. Automated compliance: the regulator will have on-demand access to the complete transaction history over the ledger

The Reserve Bank of India (RBI) has
commented on the potential of Block chain
in its financial stability report10. RBI believes
that blockchain can bring about a major
transformation in financial markets. While
it has taken cognizance of the multiple use
cases offered by blockchain technology,
it has also expressed caution over use of
virtual currencies. In its press release in
Feb’1711, RBI cautioned against the use of
virtual currencies, highlighting potential
legal, customer protection, and security
related risks. Despite RBI’s cautious stance,
Institute for Development and Research
in Banking Technology (IDRBT) came out
with a white paper12 on the application of
blockchain technology, to the banking and
financial sector in India. In the white paper,
IDBRT’s working group has proposed a
road map for the adoption of blockchain
technology in India. Recently, the Indian
government has decided to regulate
the bitcoin market, and is in the process
of establishing a task force to create
regulatory frameworks13.

7
http://indiatoday.intoday.in/story/bitcoin-value-cryptocurrency-demonetisation/1/963293.html
8
https://www.thequint.com/technology/2017/06/20/bitcoin-trades-from-india-10-percent-of-global-market
9
http://economictimes.indiatimes.com/nri/forex-and-remittance/remittances-to-india-dropped-by-nearly-9-per-cent-in-2016-world-bank/articleshow/58302935.cms
10
RBI Financial Stability Report, December 2015 (Chapter III : Financial Sector Regulation) https://rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=832
11
https://rbidocs.rbi.org.in/rdocs/PressRelease/PDFs/PR205413F23C955D8C45C4A1F56349D1B8C457.PDF
12
http://www.idrbt.ac.in/assets/publications/Best%20Practices/BCT.pdf
13
http://www.zerohedge.com/news/2017-06-20/bitcoin-surges-back-above-2700-india-legalizes-cryptocurrency
26
 FinTech in India | Ready for breakout

Investment
Management
With the development of digital tools and
services in Investment Management, this
FinTech segment is attracting a new set of
first time millennial investors. The current
penetration of investment management
services is very low, as most investors
prefer to channel their savings in deposits,
through banks.
With innovation, advisory services are
likely to break off from the product. As
customers move to automated platforms,
fewer investment management products
will be sold through own advisory
channels. This is likely to result in increased
competition amongst existing players in
specialized segments or services. Data is
seen as a major disruptor in investment
management, empowering investors and
service providers alike. Service providers
monetize data assets by targeting product
and service decisioning. Investors benefit
as they are readily provided of their
financial position, and are empowered with
tools to execute investment strategies.

Exhibit 19 Investment preference of Indian investors

% of urban investors^ that hold each investment instrument

95%

62%

30%

10% 8% 4%

Bank Life Post Office Mutual Equity Debt

Deposits Insurance Savings Funds

% of rural investors^ that hold each investment instrument

95%

47%

29%

4% 3%

Bank Life Post Office Company Pension

Deposits Insurance Savings Deposits

1 SEBI investor survey 2015, published October 2016

^ Investor - investing in banking, post office or capital market products

27
FinTech in India | Ready for breakout

Exhibit 20 Investment Management breakout Grid

Areas Fintech Creating Designing Shaping Expanding Fostering Eliminating Leveraging

Segments new value new long term market collabora- legacy data and
propositions business customer tion and constraints analytics
model behavior working
within
regulatory
purview

C. 01. Robo
Invest- Advisors
ment
02. Discount
Manage-
Brokers
ment
03. Online
Financial
Advisors

Likelihood of Breakout High Medium Low

Source: Deloitte Analysis based on interaction with Industry participants

Driven by technology evolution, a few Compared to Robo advisors, the Indian

FinTech companies have introduced Robo-
advisory services, offering automated
financial advisory services based on a
pre-defined set of rules and algorithms at a
significantly reduced cost. These platforms
leverage customer information and run
algorithms to develop automated portfolio
allocation. Information is then provided on
a portal, and via call, with a personalized
financial planner. Unlike traditional discount
brokers, Robo advisory platforms in India,
do not provide trading facilities, and the
business model is purely geared around
investment advice for balancing MFs, SIPs,
Loans, and Equity portfolios. The share of
assets managed by robo-advisers in India
is still low (less than 1% of assets), and
their services are mostly targeted toward
younger and financial savvy investors.
market has witnessed rapid growth of
discount brokering FinTech companies.
These FinTech companies offer complete
online and digital trade execution facilities,
at a fraction of the fees, as compared to
traditional brokers. Discount brokers have
no overheads of physical branches, large
research and onboarding teams, and pass
on the benefits to the investors who can
trade paying a very small fees. Specialized
discount brokers have developed
customized APIs that are extended to
sub-brokers and retail investors for setting
up customized trading platforms. A few of
the discount brokers have also partnered
with specialized equity screeners, to offer
investor stock screening services, based on
thematic and strategic research. However,
the investors are yet to adopt these
services, with these services remaining in
the purview of the investing niches.

28

Exhibit 21 Illustrative Equity Screens being offered by a market player
The GST Oppurtunity
1Y Return 35.16%
Rising Rural Demand
1Y Return 48.87%
India 24x7
1Y Return 36.93%
Source: Sample of equity screen offered by a market player
The FinTech segment likely to be a strong
candidate for breakout is online financial
advisors and distributors. These FinTech
companies operate via the online platform,
and consolidate all existing investment
accounts, such as mutual funds, equity/
depository accounts, bank accounts, credit
cards, and other accounts, and provide a
360 degree view of financial assets and the
financial health of users.
FinTech in India | Ready for breakout
The GST Oppurtunity - ...
1Y Return 34.89%
Smart Cities
1Y Return 49.55%
Affordable Housing
1Y Return 62.82%
While digital investment management is
growing, face to face consultative services
are not expected to become obsolete.
Skilled financial advisors that can create
value and offer tailored recommendations
involving high value transactions will
continue to be in demand. We foresee a
hybrid advisory model, combining personal
and digital components, as the most
promising scenario.
29
FinTech in India | Ready for breakout

Banktech
Within the bank-tech segment, globally,
blockchain remains one of the breakout
candidates in the short term; however,
in India, application of blockchain is
currently limited to a few proof of concepts
conducted by the regulator and a few
private banks. The RBI has suggested a
roadmap for the adoption of blockchain
in India, and has already conducted a
proof of concept (POC) for Trade Finance,
jointly with NPCI, SBI, PNB, HDFC, Citi Bank,
Deutsche Bank and MonetaGo.

Exhibit 22 Banktech Breakout Grid

Areas Fintech Creating Designing Shaping Expanding Fostering Eliminating Leveraging

Segments new value new long term market collabora- legacy data and
propositions business customer tion and constraints analytics
model behavior working
within
regulatory
purview

E. 01. Big Data, AI

Bank and Robotics
Tech
02. Blockchain

03. Customer
Onboarding
Platforms

Likelihood of Breakout High Medium Low

Source: Deloitte Analysis based on interaction with Industry participants

Apart from trade finance, blockchain
technology can be used for facilitating
cross border payments, insurance claim
processing, equity trade settlements,
syndicated loans with multiple lenders,
and asset hypothecation. In addition to the
benefits, most of these use cases will result
in cost optimization across the financial
services industry.

30
 FinTech in India | Ready for breakout

Exhibit 23 Use cases of blockchain technology in Banking

Priority Oppurtunity Spaces Rationale

Cleaning
Reconciliation
Custody 2 days faster trade settlement could unlock
1
Trade Matching savings to the tune of $2.7B annually
Trading &
Settlement
Blockchain
2 Potential to reduce processing time to
technologies
Remittance 3.6 seconds and lower transaction fee from
could reduce
Business to Business ~6.0% to 1.0% - 2.5% leveraging Blockchain the
bank's
Business to Consumer underlying settlement rail
Payments infrastructure
costs by
Financial Derivations $15-20B a year
Corporate Bonds by 2022 Strongest client interest as evidenced by
3
P & C Insurance engagement with Blockchain ecosystem
Real Estate Transactions and intrest expressed in conversation with
Smart Smart Investment Plans Deloitte SMEs
Contracts Collateral Management
Contact Automation

Source: Deloitte Analysis

Despite strong reasons and ongoing PoCs,
the barriers to adoption of blockchain
will remain high for a few years. Issues
including Data security, associated financial
risk, and regulatory acceptance are major
barriers for FinTech companies operating in
this segment.
Customer onboarding remains an area
where there is high degree of customer
friction. A few of the FinTech companies
focusing on customer onboarding and
authentication solutions in India have
received recognition, not only from partner
banks and NBFCs, but also from regulatory
authorities. FinTech companies are also
deploying Artificial Intelligence (AI) and
blockchain to authenticate, validate identity
and undertake background checks on
customers. These capabilities are likely
to improve the overall quality of digital
onboarding for both, incumbent banks, as
well as, other FinTech companies. FinTech
companies focusing on digital customer
onboarding are likely to face tailwinds as
other FinTech companies rely on these
basic services to gain trust and improve
fraud management capabilities.
Emerging FinTech segments in the areas of
Artificial Intelligence (AI), Machine Learning
(ML) and robotics are emerging, albeit in
the nascent stages. Most of these FinTech
companies are working with banking
partners to improve current operations
and servicing. A few private sector
banks have been working with FinTech
companies to automate certain customer
servicing activities in call centers. Globally,
financial services are also adopting AI for
compliance, anti-money laundering and
risk management. However, some of these
underlying technologies remain a niche in
India.

31
FinTech in India | Ready for breakout

InsurTech
Despite strong improvement in penetration
and density in the last 10 years, India
largely remains an under-penetrated
market. The market today is primarily
dependent on push, tax incentives, and
mandatory buying for sales.
InsurTech primarily aims at enabling
a better reach of insurance products
& services, as well as a greater
personalization of insurance products, and
proactive management of key risks.

Exhibit 24 InsurTech breakout Grid

Areas Fintech Creating Designing Shaping Expanding Fostering Eliminating Leveraging

Segments new value new long term market collabora- legacy data and
propositions business customer tion and constraints analytics
model behavior working
within
regulatory
purview

F. 01. Insurance
Insure Aggregator
Tech
02. IOT and
Wearables

Likelihood of Breakout High Medium Low

Source: Deloitte Analysis based on interaction with Industry participants

Insurance aggregators compile and provide
information about insurance policies
on a website, and are regulated as per
the Insurance Regulatory Development
Authority (IRDA) Web Aggregator
regulations, 2017. Insurance aggregators
are essentially a digital distribution channel
allowing customers to compare scope
of coverage, term, premium, and terms
relevant for customers to enable them
to make an informed decision. With a
penetration of over 400 Mn Smart Phones
by 2020, the digital insurance channel will
be an important medium for distribution
of Insurance products. We believe the
most likely break out due to the Insurance
aggregation business model, will be the
aggregators disaggregating the distribution
of policies and the ownership of customer
relationships from Insurers. This will lead to
reduced customer stickiness, self-service
models, and competitive benchmarking of
insurance products.
Increasing adoption of connected devices
e.g. telematics, and wearables presents
an opportunity for Insurers to better
understand customers and personalized
customer engagement. This will require
Insurers to work closely with device and
service providers. A key consideration
will be, definition of boundaries in using
personal data of customers. It will require
close partnerships between insurers,
re-insurers and product/ platform
companies. For example, Max Bupa
recently announced an alliance with GOQII,
a wearable and a fitness technology
player, and Swiss RE, a global re-insurer.
With wearables shipments at 2.5 Mn14
units in 2016 and growing, we believe that
wearable data will increasingly be leveraged
by Insurance companies to personalize
insurance policies, actively manage the
insured’s risks, and eventually broker
personal data by partnering with 3rd party
players for improved health & wellness of
an individual.

14
https://www.idc.com/getdoc.jsp?containerId=prAP42423317

32
 FinTech in India | Ready for breakout

Personal Finance
Management
Personal Finance Management refers
to a software/ app or a platform that
helps the user manage his/ her money.
Managing, spending, and investing money
are important decisions that have a
profound impact on the financial health
of the individual. Most customers know
the basics of money management, but are
not financially savvy enough to manage
on their own. This is where the personal
finance management app comes into
the picture. These apps have gained
popularity in the last couple of years and
they assist customers in keeping a watch
on their expenses at a single place. Key
enablers in support of the personal finance
management app are:
01. Regulations: The RBI, in its guidelines
has instructed banks to send
notifications on every transaction
to customers. Personal Finance
Management apps have leveraged this,
to provide an overview of all spends of
a customer.
02. Data scraping: Another important
factor in the development of the
personal finance management app is
the technology of data scraping. Data
scraping has enabled personal finance
management apps to read messages of
customers, and analyze transactions.

Exhibit 25 Personal finance breakout Grid

Areas Fintech Creating Designing Shaping Expanding Fostering Eliminating Leveraging

Segments new value new long term market collabora- legacy data and
propositions business customer tion and constraints analytics
model behavior working
within
regulatory
purview

D. 01. Tax Filing and

Per- Processing
sonal
02. Spend
Finance
Management
Manage-
and Financial
ment
Planning

03. Credit
Services

Likelihood of Breakout High Medium Low

Source: Deloitte Analysis based on interaction with Industry participants

33
FinTech in India | Ready for breakout
Key challenges for
Indian FinTech
The Indian FinTech sector faces common
challenges that could impact its growth
momentum. Most of these are structural,
and are likely to have an impact on most of
the FinTech segments.
01. Regulations: Balancing Act to foster
innovation
Regulation will be a double edge
sword for Indian FinTech companies,
as increased regulation could stifle
innovation – the hallmark of FinTech,
and drive up operational costs.
However, regulatory clarity will
strengthen the sector in the long
run, help it gain customer trust, and
thereby attract more capital. As FinTech
companies, scale-up, they are likely to
face more scrutiny from regulators. A
number of interventions have been
undertaken including Bharat Bill
Payment System (BBPS), Payments
Bank Licenses, Unified Payment
Interface (UPI) etc. RBI has also adopted
a consensus driven approach to
introduce regulations for new sectors,
including P2P and aggregators. The key
challenge for the regulator is to create
an environment that fosters innovation,
while adequately addressing concerns
on customer protection, data security
and privacy. Due to the accelerated
rate of innovations, regulators end
up playing catch-up ,and may have a
knee jerk response to certain market
activities.
34
02. Gain trust and improve perceptions
through literacy
Trust has always been an important
factor in the Financial Services
industry. Indian consumers are known
to have a conservative mindset and
traditionally had more comfort in
physical transactions, including the use
of cash. Although the percentage of
population under the ambit of banking
has increased, the unbanked and
underbanked segments have limited
knowledge of banking services. Hence,
it’s a challenge to build trust and adopt
services offered by FinTech companies.
FinTech is a relatively new segment
and it is yet to gain trust as a reliable
financial services alternative. Changing
the way consumers perceive and avail
financial services is fundamental to
the widespread acceptance of the
FinTech sector. It is equally important
to educate the target audience about
the merits of availing financial services
through FinTech, and the onus will lie
on FinTech to improve literacy and
perceptions.
03. Financial Infrastructure and
utilities
Building a new-age FinTech
business calls for building data and
infrastructure, which is not easily
available in India. FinTech companies
need more data to create a value
proposition for customers. Currently,
only a small percentage of the working
population is represented by credit
bureaus or traditional banking
channels.
Further, most of the companies
are focused on consumers/ payers
with less emphasis on acquiring
infrastructure by broader base of
merchants. Non-availability of digital
infrastructure at merchants, is a major
challenge. There is an urgent need
to expand digital infrastructure at
merchants. The Government, in the last
three years, has taken major steps to
expand digital infrastructure, such as
internet penetration, and Merchant QR
code in the country.
04. Cyber and Data security
As Indian FinTech companies scale up
in number and sophistication, they
are likely to establish interfaces with
banks and other information sources
such as the UID database. Interfaces
between systems could present
cyber vulnerabilities, and data security
issues. Moreover, as FinTech companies
embark on data based differentiation,
the issues of data privacy and customer
protection have to be paramount.
FinTech companies will not have access
to sensitive financial information about
customers, but are likely to collect
personal customer information in
their quest to know more about the
customer. Interfaces and APIs that
facilitate seamless data hoops with
multiple applications may also be
most vulnerable and create prospects
for malware propagation, in case of
cyber-attacks. Developing strong
defense mechanisms and procedures
to address these concerns will be an
imperative for the FinTech sector, just
the way it is for incumbent banks and
financial institutions.
 FinTech in India | Ready for breakout

Conclusion
Indian FinTech companies could address •• The FinTech industry will develop
a few of the critical structural issues unique and innovative models of
afflicting Indian financial services - increase assessing risks. Leveraging big data,
outreach, improve customer experience, machine learning, and alternative data
reduce operational friction and foster to underwrite credit and develop credit
adoption and usage of the digital channel. scores for customers with limited credit
Legacy prone processes and higher history, will improve the penetration of
operating cost models of incumbent financial services in India.
banks and financial service providers will
•• FinTech will create a more diverse,
give digital FinTech companies an edge,
secured and stable financial services
as banks play catch-up with these more
landscape. FinTech companies are less
nimble and innovative start-ups. The
homogenous than incumbent banks, and
opportunity for FinTech lies in expanding
offer great learning templates to improve,
the market, shaping customer behavior,
both, capabilities and culture.
and effecting long term changes in the
financial industry.
Just as incumbents have a lot to learn from
emerging FinTech companies. Fintech
Indian FinTech companies have the
companies can also learn and adopt best
potential to reshape the financial services
practices around risk and internal controls,
landscape in three ways:
operational excellence, compliance culture,
•• The FinTech startups are likely to reduce and employee engagement, that has stood
costs and improve quality of financial the test of time for most the banks, and
services. Not being burdened with legacy financial services providers in India.
operations, IT systems, and expensive
physical networks, benefits of leaner
operating models can be passed on to
customers.

35
FinTech in India | Ready for breakout

Appendix
Approach
In the Indian context, FinTech can be
broadly aligned across twenty segments,
across six broad financial services areas.
The contours of these twenty segments
are broadly in line with the findings of
Deloitte global research on “Future of
Financial Services”, which was jointly
conducted along with World Economic
Forum and highlights the emerging areas of
innovations in the financial services sector.
The twenty segments are described in the
table below.

Areas FinTech Segments Brief Description

A. Credit 01. Peer-to-Peer Lending
02. Crowd Funding
03. Market Place for Loans
04. Online Lenders – on-book lending by
NBFCs
05. Credit Scoring Platforms
•• All forms of lending market places including Peer-to-Peer lenders
and market places that connect borrowers with both institutional
and non-institutional lenders;
•• Also, includes crowd funding and equity funding platforms
•• NBFCs that use alternative scoring and digital channels for
acquisition

B. Payments 06. M-wallets and PPIs •• Services that enable transfer of funds for various use cases
07. Merchant Payments and PoS Services - P2P (Person-to-Person), P2M (Person-to-Merchant), G2P
08. International Remittance (Government-to-Person) etc.
09. Crypto Currencies
•• Services targeted at both Payee and Merchants by enabling
requisite payment infrastructure through mobile or other
technologies

C. Investment 10. Robo Advisors •• Wealth advisory services delivered through technology governed
Management 11. Discount Brokers rules and investment strategies
12. Online Financial Advisors

D. P
 ersonal Finance 13. Tax Filling and Processing •• Tools and services for active management of individual financial
Management 14. Spend Management and profiles (e.g. spend, investments, credit profile, etc.)
Financial Planning
15. Credit Scoring Services

E. Bank tech 16. Big Data •• Services that utilize many data points such as financial
17. Blockchain transactions, spending patterns to build the risk profile of the
18. Customer Onboarding Platforms customer. This provides an alternate to traditional underwriting
methods that are unable to serve people with limited credit data.

•• There is significant value in unstructured data. However, it

is difficult to derive value from unstructured data, owing to
challenges in analyzing it. A number of new tools are being
developed to derive value from large data sets.

F. InsurTech 19. Insurance Aggregator •• Small business insurance

20. IOT, Wearables and Kinematics
•• Usage based insurance

Source: Deloitte Analysis

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 FinTech in India | Ready for breakout

All the segments of Indian FinTech have
started gaining ground albeit to different
extents, due to different underlying
characteristics that impact scalability,
adoption and viability. Moreover, not all
the segments are likely to breakout at
the same time. In order to assess the
breakout potential of each segment of
Indian FinTech companies, as well as the
timing of breakout, Deloitte has developed
a customized FinTech breakout assessment
framework for the Indian FinTech market,
drawing from the learnings of the Future
of Financial Services study. The framework
qualitatively grades the 20 FinTech
segments across the seven characteristics
on three parameters (High, Medium and
Low) highlighted in the table below:

FinTech Breakout Characteristics Strategic Theme Addressed

01. FinTech companies that are addressing areas and functions where customer friction Creating new value propositions
meets largest profit pools (economic value)

02. FinTech companies that employ business models that are platform based, modular, Designing new
data intensive, and capital light to start with business model

03. FinTech companies that actively shape customer and user behaviors, thus resulting in Shaping long term customer behavior
long-term structural change of the financial services industry

04. FinTech providers that offer services to the underserved population, small and mid- Expanding market
sized businesses, using sophisticated capabilities on viable basis

05. FinTech companies that actively collaborate with Banks and other FIs and also operate Fostering collaboration and working within
within the regulatory purview or active consideration purview of regulators regulatory purview

06. FinTech companies operating in segments with significant legacy issues and prevalence Eliminating legacy constraints
of conventional business models, that lack scalability

07. FinTech companies that target customers and make curated offers through Leveraging data and analytics
use of analytics and alternative / big data sources

Likelihood of Breakout High Medium Low

The framework aims to address the
considerations across a range of business
aspects, including scalability, business and
operating model alignment, addressing
new market opportunities, ability to
create and serve new market segments,
collaborating and partnering with banks.
Using the above framework, our team
analyzed various aspects of businesses
and consulted industry participants to
understand their breakout potential. Based
on the analysis of the 20 segments, the
results are summarized in the figure below.
The areas marked in darker shades indicate
a higher likelihood of breakout when
compared to other FinTech segments.

37
FinTech in India | Ready for breakout

Online Lenders -
Market Place NBFCs using own
Crowd for Loans capital Credit Scoring
Funding Platforms

Peer-to-Peer M-wallets and

Lending PPIs

Merchant
Payments and
PoS Services

International
w
or

vie
s
ion

Remittance
av i

ur
del

yp
eh
osit

mo

to r

s
rb

t
ain
ul a

s
prop

ti c
ome
es s

re g

s tr

al y
busin

et

t hi n

on
v a l ue

cust

an
Mark

cy c
nd wi

nd
Shaping long term
Designing new
Creating new

Crypto
at a a
Expanding

Eli m i n a t i n g l e g a
t in g w i t h b a nk s a

Currencies
e r a g i n g d
Co lla b o r a

Le v

Robo
Advisors

Discount
IOT and Brokers
Wearables

Insurance
Online Financial Advisors
aggregator
and aggregators

Customer Onboarding Tax Filling and

Platforms Processing
Blockchain Spend
Big Data Credit Management
Services and Financial
Planning

Likelihood of Breakout
High Medium Low

Source: Deloitte Analysis based on interaction with Industry participants

38