The Kauffman Foundation, a Kansas City based nonprofit focusing on entrepreneurship and education, recently presented its Annual State of Entrepreneurship Report at its annual event, revealing three megatrends that are reshaping business in America. Of particular note was the new map of entrepreneurship: Entrepreneurship is expanding from expensive big cities on the coasts to more affordable midsize cities throughout the country. The Kauffman report specifically names Charlotte a hot spot for new entrepreneurship, with access to venture capital and alternative means of financing, specifically crowdfunding, driving that growth.
Small businesses frequently need capital, and for many, they’ve found it in crowdfunding, a fast-growing, web-based system of raising funds from individuals around the world. Sites like Kickstarter, Indiegogo, and Rockethub allow campaigners to seek a sum of money to get a project off the ground. Campaigners create a pitch that educates potential funders on their project (and any reward they’ll receive for becoming a “backer” -- anything from free t-shirts to equity in the company), and supporters then use their credit cards to make pledges. In this way, businesses gain access to capital far outside the conventional lending system.
Crowdfunding is easy. So easy that businesses often neglect to research potentially unfavorable tax, financial, or legal implications from their campaigns. Funds raised through crowdfunding, when used for business ventures, are considered taxable income in the eyes of the IRS (and potentially your home state). Crowdfunding websites will often issue a Form 1099-K, Payment Card and Third Party Network Transactions, to the campaign organizer receiving the funds. If you’re not careful, you could end up in serious financial trouble.
If you’re thinking about crowdfunding your next venture, we urge you to seek tax, legal, and business advice. Here are 3 things to consider in those meetings:
- How will crowdfunding my project affect my taxes?
Your individual, company, and/or nonprofit tax issues and financial precedents have the potential to derail the effectiveness of fundraising campaigns. Work with your tax professional to determine if crowdfunding is a smart financial decision.
- What tax issues might affect the beneficiaries?
It is not enough to consider the tax ramifications for the campaign; if there are separate beneficiaries, their tax issues may dictate a different approach to raising funds. Again, discuss these issues with your tax professional.
- Will crowdfunding affect the structure of my business or nonprofit?Sometimes fundraising plans direct long-term goals of the enterprise. Discuss structural issues in advance with your advisors to tackle both tax issues and better strategies for fundraising and long-term mission, if applicable.
The bottom line is this: Crowdfunding for business can be an effective strategy but it’s not “free money”. The tax man will come to collect. Make a preliminary call to your qualified advisors before launching any online fundraising effort.