Possible impact of SEBI's proposed crowdfunding model (WSJ/Mint)

When Manish Kumar, 32, saw Menstrupedia’s crowdfunding campaign, he says it touched his heart, leading him to contribute Rs.500 to the project in exchange for a handwritten thank-you note.

“I have two sisters and hence I found a personal connection to the larger problem addressed by the project,” says Kumar. Menstrupedia aims to educate young girls about menstruation through a comic book and a website.

Currently, in India, crowdfunding—financing a proposed project online through relatively small sums from a large number of people—is restricted to a reward and donation model. Here, contributors to a project in the domain of, for example, design or technology, receive some reward ranging from a thank-you note to the product itself, based on the contribution. In some social-cause projects, there are no rewards for the donation.

However, recently, the Securities and Exchange Board of India (Sebi) proposed a crowdfunding framework for India in a consultation paper, on which it had invited public comments by 16 July. The introduction of a potential investment model of crowdfunding, where contributors to a project will receive an equity share of the company, will cause a paradigm shift in the constitution of sectors within the industry and in the profile and psychology of contributors: broadly from heart to head.

According to Abhishek Maitra, executive director of the National Crowdfunding Association of India, the investment model will turn the tables around completely. “People would no longer contribute based only on their emotional urge as they currently do in reward and donation models. Most of it would be based on logic, their understanding of the market the projects are based in, their risk appetite, their ticket size, and most importantly, their desire to make the right choice and gain maximum profits,” he says.

One reason for the above change would probably be a change in the profile of contributors under the reward model and the investment model. Anshulika Dubey, co-founder of Wishberry, one of India’s largest crowdfunding platforms that hosts reward-based projects across categories, says that about 70% of contributors to a project on an average are family and friends of the campaigner. However, Maitra says that under the proposed investment model, contributors would comprise mature investors who make decisions on the basis of company valuation, revenue and return on investment.

Satish Kataria, formerly a venture capitalist who in 2010 introduced equity crowdfunding in India in association with a European crowdfunding platform, Grow VC, seconds Maitra: “Following US’s JOBS (Jumpstart Our Business Startups) Act, which has been inspiring equity crowdfunding regulations across the world, Sebi has proposed to allow only accredited investors to put their money in investment model crowdfunding projects.” Sebi’s definition of accredited investors includes institutional investors, companies with a minimum net worth of Rs.20 crore, high net-worth individuals, and financially secure and informed retail investors.

Kataria was able to operate an equity crowdfunding platform escaping Sebi’s purview by limiting the number of investors to 49. (The maximum number of investors allowed in a private company was 50 then. The new Companies Act now permits up to 200 investors in a private company.) Hence, unlike the reward model where there is no upper curb on the number of contributors, there would possibly be a restriction on the number of investors under the equity model. Moreover, the funding goals are also much higher under the equity model.

Kataria, in 2013, started Catapooolt, a crowdfunding platform for hosting creative projects like movies and music festivals. He estimates that Rs.10 lakh would be the starting funding goal of equity crowdfunding projects in India, a point which forms the maximum raise for their reward counterparts.

Tim Wright, a Scotland-based consultant on crowdfunding, says that statistically, the average investment size in the equity model tends to be higher than the average contribution in the reward model.

Expectation of reward or return—a parameter for presence of logic in the contribution decision—is directly correlated to the amount of contribution irrespective of the crowdfunding model. Except in cases like Kumar’s where the contribution amounts to a few hundred rupees for a cause very close to the contributor’s heart, people do expect tangible rewards even from social projects.

Varun Sheth runs a reward and donation crowdfunding platform, Ketto, for social-cause projects. He agrees that projects with rewards have a higher probability of being successfully funded than their donation-based counterparts. “Rewards act as the incentive for larger donors to contribute to X project rather than to Y.” Thus, although the reward-based model is not as pure as anonymous donations, it is relatively more heart-centric than the equity model.

One reason for this is that it allows contributors to give smaller amounts. Apart from the contribution amount, expectation of reward also varies across project categories. Product-based projects that offer the end product as reward—for example, technology projects—engage the head of contributors more than their hearts. When Mahima Kukreja contributed Rs.250 to Printajoy, a printing solution for Instagram photos, she did not care so much about the intangible or non-monetary reward: a shout-out on Facebook. Instead, she thought she got a “good package” (20 prints at Rs.250 which would later be available for Rs.279). Thus, people may contribute small sums to support girl education or a budding artist, but when it comes to a technology product at offer, they tend to think less emotionally and more logically.

Currently in India, a majority of reward-model crowdfunding projects are in the social and creative space. There are very few technology projects, making it a more heart-based contribution scenario. However, Maitra predicts that under the proposed equity model, technology would be the first sector to catch up. “Everything from online technology companies to hard-core technology companies are booming in India and that’s the sector most investors understand,” he reasons.

Lastly, a shift from heart to head is also demonstrated by the fact that contributors in the reward model lay a lot of emphasis on the campaigner or team behind the project, whereas investors in the equity model focus on the business plan. For example, Chandan Shanbhag, a software engineer, contributed to Lawtoons, a project that intends to spread legal awareness through a comic book, merely because the campaigner is his friend. This puts him in the 70% inner circle mentioned by Wishberry’s Dubey. But even for Kukreja who did not know the Printajoy campaigners personally, it was important to trust the team behind the project after finding the concept attractive and before making the contribution. “I read their blog from which I got good vibes about the campaigners. They seemed passionate and down to earth,” she says.

On the other hand, Ryan Caldbeck, co-founder of Circle Up, an accredited investor crowdfunding platform based in the US, advises companies to talk about market, growth prospects, historical financials, projected financials, planned use of capital and such in their online elevator-pitch. Dubey reasons, “The reward model is primarily for product launch and the audience does not care about project scale, whereas an investment model will heavily depend on whether a project has scale or not.”

The only reference check that Kumar did before contributing to Menstrupedia was that the campaigner was a friend of his friend. He says, “The project was endorsed by my friend and that lent credibility to it.”

Read on Wall Street Journal/Mint website here