Photo by Rob Curran on Unsplash
“Is crowdfunding considered income?” Yes. Reward-based, equity, and donation-based crowdfunding are generally going to be treated as income by taxing authorities. Debt and real estate crowdfunding, due to their unique nature, will most likely not be considered income. However, if crowdfunding is used for business purposes, expenses can be deducted against the income.
Of course, none of this is tax advice. You should consult with a tax professional before starting a crowdfunding campaign.
Crowdfunding is fundraising in the age of social media. It is a rapidly growing means for businesses and individuals to raise money.
There is no such thing as a free lunch. Or, so they say. Donors who contribute to crowdfunding campaigns will typically expect to repaid tangibly or intangibly.
Generally speaking, there are five types of crowdfunding. Most of which need to be paid back in one manner or another.
Many entrepreneurs and startups will use this type of crowdfunding to raise funds for a given project or the organization as a whole.
Donors are paid back with rewards. Often, the rewards are proportionate to the amount contributed.
Frequently, the reward will be the product or service that the crowdfunding proceeds were raised for. In other words, if an entrepreneur has an idea for a new product, they can start a crowdfunding campaign and repay donors with free product once manufacturing begins.
This is like traditional equity financing for a small business. Except, instead of offering equity in the company to select investors, it’s offered to the public as a whole. This type of crowdfunding is not paid back directly. Rather, donors are repaid through the appreciation of their equity.
Equity crowdfunding is also known as investment crowdfunding or crowd-investing. Since the funds raised are for getting a company off the ground, a considerable amount is usually needed.
Every donor will receive partial ownership in the newly-created company. Of course, the amount of ownership depends on the amount contributed.
Equity crowdfunding enjoys many of the same advantages and disadvantages as traditional equity financing.
This type of crowdfunding is better known by another name – peer-to-peer (P2P) lending. Like all borrowed money, debt crowdfunding needs to be paid back – with interest.
Debt crowdfunding is often used by individuals and less so by businesses.
It is similar to traditional debt financing in many respects. Funds are paid back on the P2P platform. From there they are dispersed to the lenders/donors. Interest is charged on the borrowed funds and repayment is made on an installment basis.
For a small business, debt crowdfunding has many of the same pros and cons as traditional debt financing.
Real estate crowdfunding connects investors with real estate opportunities. This allows investors to diversify and participate in real estate investments without actually obtaining financing and dealing with ownership.
Investors can also get away with contributing considerably less than they would if they were participating in a traditional, large-scale, real estate investment.
This type of crowdfunding is paid back to the investors by the orchestrator of the real estate deal. Payouts are typically made quarterly and are dependent on the revenue-generating performance of the real estate investment.
This type of crowdfunding is more related to charity or fundraising than business uses. As such, it does not need to be paid back with cash.
Donation-based crowdfunding is typically used to raise money for personal needs or community projects. Oftentimes, fundraisers will go viral when they are for an especially empathetic cause.
Raising money for people who need help with medical expenses, financial hardship, or things such as a community garden are examples of donation-based crowdfunding.
Even if the type of crowdfunding utilized does not require cash payback, contributors typically expect to see some sort of tangible return on the money they donated. That return could be as simple as seeing their donations contribute to some sort of net positive for society.
With all types of crowdfunding, there are fees withheld by the platform. This is how they earn their money and continue to serve as middlemen between donors and fundraisers.
Raising money through crowdfunding takes considerable effort. So, there is a cost beyond dollars and cents.
First of all, it is necessary to create a compelling story. A reason for your potential donors to contribute to your crowdfunding efforts. This is not to say that the story should be fabricated or embellished. Rather, it must be conveyed in such a way as to pull on potential donors’ heartstrings and purse strings.
The other challenge is the marketing of your campaign. Crowdfunding is a heavily-used and continually-growing medium for raising funds. If you want to meet your funding goals, you’re going to have to exert considerable effort to get your campaign in front of eyeballs. This effort can be your own, or you can hire help.
Finally, if you set up a donation-based or reward-based crowdfunding campaign, you need to be prepared to return that money if you can’t meet the goals you promised…
Generally speaking, there are two options when raising money via crowdfunding.
With the “all or nothing” option, if you don’t hit your target, then no money will be taken from your supporters. The crowdfunding money is paid back to them automatically.
Alternatively, with the “keep what you raise” option, you receive whatever has been donated. Less the platform’s fees, of course. If you’ve raised considerably less than you anticipated, then the scope of your project will probably have to be scaled down.
Obviously, with the “keep what you raise” option, you would be required to pay back what you raised subject to the requirements of that particular type of crowdfunding.
If you don’t pay back your crowdfunding proceeds as outlined in the terms of service, then you could be compelled by the law to pay it back…
Crowdfunding can be good, bad, or ugly. One example each of successes, failures, and frauds are listed below
The Oculus Rift virtual reality headsets were the offspring of a 2012 crowdfunding campaign. At the time, the campaign raised $2.5 million dollars from 10,000 or so donors.
Two short years later, Oculus was purchased by Facebook for $2 billion. One hell of a return on investment.
Induratus might’ve been a good idea. But, the creator of this crowdfunding campaign either failed to create a compelling story or failed the market his campaign effectively.
Induratus’s crowdfunding campaign had a goal of nearly $5 million CAD. Unfortunately, it only managed to raise one single solitary CAD, as of 2015.
In 2014, the creator of the Coolest Cooler ran a reward-based crowdfunding campaign that raised a whopping $13.2 million dollars.
Donors we’re promised coolers once manufacturing was set up. Unfortunately, production delays and other problems resulted in tens of thousands of donors getting stiffed. By 2017, Coolest Cooler had to settle with the Oregon Department of Justice.
Crowdfunding can be a great way to get your startup off the ground. However, before you start a campaign be sure to educate yourself on the tax ramifications of your particular type of crowdfunding. Also, be sure to pick the type of crowdfunding that is right for your project or business.
Make sure to create a compelling story and have a marketing plan ready for your crowdfunding campaign. this will help ensure that your campaign is successful and meets the goals of your small business.
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