By Colleen S. Krcelich, CPA | Northampton Community College
You have a great idea for a new product – one that is sure to make millions! The problem is you have no money to develop your idea. You are already buried in student loan debt and a mortgage, so another loan is not an option. You may want to consider posting your idea on a crowdfunding site. It may be the next big hit, like the card game Exploding Kittens (raised $8.8 million) or the Fidget Cube (raised $6.5 million).
Crowdfunding sites can be broken down into four general types of fundraising:
- Rewards-based (Kickstarter and Indiegogo): Used to fund products or projects.
- Donation-based (GoFundMe, YouCaring): Used to fund social causes and charities.
- Equity-based (Angelism, Crowdfunder): Used to fund businesses via ownership.
- Debt-based (Lending Club, Prosper): Used to secure a loan for those who can't get one through conventional financing, typically at a higher interest rate.
Reward- and equity-based crowdfunding platforms are the most popular for businesses. When choosing crowdfunding to finance your great idea, here are a few important points to keep in mind.
Rewards-based sites:
- These sites charge a fee for their services, usually 5 percent, as well as a per transaction processing fee of about 3 percent to 5 percent.
- If you do not raise your entire goal, the project is not funded.
- You are expected to complete the project and fulfill each reward. If you cannot complete it, you are expected to find a resolution, which could include offering refunds, and detail exactly how funds were used and what went wrong.
- Money raised is typically considered taxable income, and is taxed in the year it is received. If a campaign is done late in the year, you may not have expenses to offset the income and could incur a large tax bill, which could cause a lack of funds to fully develop your product or project.
- When using these sites, limit your rewards to what you can actually fulfill. Do not offer 5,000 rewards if there is no way you can manufacture and ship that many items.
- Make sure you have a good estimate of the cost to manufacture and ship your items, including the development costs, so that you do not lose money on the project.
- Only 44 percent of projects are successfully funded.
- Some sites, including Kickstarter, can reject a project outright.
- A funder’s credit card is not run until a project is fully funded. By the time the project is funded, some pledges via credit card may no longer be valid, so you will not receive some pledges.
Equity-funding platforms:
- These sites are a good way to raise capital without having to go through a full public stock offering.
- When using equity funding, you are selling an ownership stake in your business, and diluting your ownership.
- These sites are a great opportunity for companies that may be unattractive to larger venture funds.
- They are appealing for small businesses and startups that need to raise smaller amounts to be successful.
- As of May 2016, anyone can invest in a business via crowdfunding, regardless of income or net worth. Investors no longer need to be accredited (income over $200,000 or net worth in excess of $1 million).
- A nonaccredited investor is limited (based on net worth) as to how much they can invest to protect them from losing their life savings on a failed company.
- Money raised is typically not considered taxable income.
- Equity funding is a great way for customers and fans to gain ownership in your business.
- If your business succeeds, your investors have a chance to share in your success.
- Once someone invests in your company, they must understand that there is probably not a market to sell those shares in the near future.
- Investors must understand that this is a high-risk investment.
- You must be able to track your investors, and a spreadsheet may not be adequate. Software programs are available, but they are typically expensive.
Crowdfunding sites are an area to consider when looking to fund a business or your new product idea or project. There are both benefits and pitfalls to using these sites. As always, consult a legal team as well as your CPA before embarking on this journey.
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