Why Crowdfunding Works—But Only If You Play By the Rules

It might seem too good to be true, but crowdfunding makes it possible to get money for everything from starting a new business to paying off a student loan.

For example, electric bike company EVELO raised $750,000 with crowdfunding:

“The amazing advantage of crowdfunding is that it really lets you engage and learn from your community,” says the company’s founder, Boris Mordkovich. “They support us and we support them, and that helps us strengthen our brand and continue to improve our product and customer service—things you can’t do if you just get money from a bank.”

Can you make the process work for you?

Different Types of Crowdfunding

There are two main types of crowdfunding: donation/reward and securities. 

Let’s learn a bit more about them.

Donation/Reward Crowdfunding

Pedro Flores, of digital marketing agency CrowdfundX, defines donation/reward crowdfunding as “the process of raising money in order to launch a project—create a movie, build a product—in exchange for a thing related to the project—a ticket to the movie, a prototype of the product.”

Getting started in this type of crowdfunding is pretty straightforward.

“Select a crowdfunding platform like Kickstarter or Indiegogo, enter the details of your project, and publicize the campaign to everyone you know,” says Flores.

Promote from the platform itself, over social media, or with the help of a marketing agency.

Securities Crowdfunding

“Securities crowdfunding lets people invest money into a company to get a share in the company,” explains Flores. “If the company succeeds, the crowdfunding investors may stand to gain, too.”

Getting started in securities crowdfunding is a bit more complicated, though.

“You’ll need a lawyer to set up a company and help you comply with the disclosure rules that are established by the Securities and Exchange Commission (SEC),” says Flores. “You’ll pick a securities crowdfunding platform like StartEngine or Wefunder, upload all of your information, and file with the SEC. You can then do limited marketing outside the platform.”

EVELO went with this equity-based option, which has taken off since the 2012 Jumpstart Our Business Startups (JOBS) Act.

The JOBS Act makes it less cumbersome for companies to seek capital, but the funding “acts like a traditional investment: those who buy in then own a part of our company,” says Mordkovich, who used the SeedInvest platform.  

“You’re essentially just promoting your idea—so have a business plan that makes the case for why it’s going to work, information about how great your team is, and product photos, details, and timelines,” says Mordkovich. “Fill out the application, hope for approval, promote the idea to everyone you know, and hope they do the same.”

Promoting can absolutely make or break your seed funding efforts.

“Successful crowdfunding campaigns incorporate a strategic combination of PR, marketing, social media, videos, and even radio and TV appearances,” according to tax attorney Andrew Goldberg, whose firm has been advising entrepreneurs for more than 25 years.

Crowdfunding & the Federal Trade Commission

The Federal Trade Commission is involved in crowdfunding, but it doesn’t take too much of a proactive role in regulating it.

“The FTC only responds to complaints from consumers,” Goldberg explains, “most commonly that the crowdfunding sponsor misled consumers about how the money would be spent or failed to provide the promised reward when the fundraising goal was met.”

The FTC filed its first crowdfunding complaint last summer against Erik Chevalier, who raised more than $100,000 to make a board game… But used the funds for other purposes.

Because the project was abandoned and the investors didn’t receive the product they were promised in exchange for their contributions, the FTC has required Chevalier to pay back the money.

The FTC will investigate reportedly fraudulent donation/reward campaigns, but not securities crowdfunding. “Securities crowdfunding remains in the realm of the SEC,” says Flores.

Can Crowdfunding Get Taxed?

The IRS doesn’t specifically address money raised by crowdfunding.

“If a crowdfunding project collects money and gives a reward, the money will be considered income,” Goldberg explains. “However, the project will be able to offset this income with the value of the rewards paid out and other business expenses, just like a normal business would.”

If there’s no reward given—a campaign to raise money for a person’s expensive surgery, for example—the rules get more complicated.

“It might be that the contribution is considered a gift or another form of contribution,” says Goldberg. “Ironically, the person who receives the gift doesn’t have anything to report, but the person who makes the gift might have to report this on a tax return.”

Flores recommends hiring a good accountant who knows how you should record the money.

Is Crowdfunding Risky?

Donation/reward crowdfunding requires honest disclosure.

“If you don’t do what you said you were going to do, you could be in trouble,” cautions Flores. “Protect yourself by fully explaining the risks and uncertainties involved with your venture and by explaining exactly what you’re going to do to bring the project to fruition.”

Misrepresenting your project in securities crowdfunding can get you sued by the SEC, state securities regulators, and investors.

“Protect yourself by hiring a lawyer to look over the information you provide to investors,” Flores advises.

When Crowdfunding Isn’t the Way to Go

“There’s no list of specifically prohibited crowdfunding projects, but each crowdfunding platform might have its own list of prohibited projects,” says Goldberg.

You can’t, of course, use crowdfunding for illegal activities, nor can you raise seed funds in exchange for alcohol, tobacco, or firearms.

And it might get a little complicated beyond that, too.

“If someone starts a crowdfunding project in a state where marijuana is legal and a resident from a state in which it’s not legal contributes to the fund, is it legal?” muses Goldberg. “Who knows!?”

The post Why Crowdfunding Works—But Only If You Play By the Rules appeared first on Fundera Ledger.

from Fundera Ledger https://www.fundera.com/blog/2016/06/17/crowdfunding-works-play-rules/