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Is Crowdfunding Right for Your Business?  

by
Sherri Hastings
on
1/26/2017
Is Crowdfunding Right for Your Business?  

Crowdfunding has become very prominent in recent years with all kinds of interesting projects proposed by a mix of established companies and individuals looking to embrace their creative and entrepreneurial spirits. While crowdfunding can be used to raise equity funding (within Securities Exchange Commission limitations) for later-stage companies or for personal purposes such as for help paying medical bills or for a reward such as item of the end product.  Funds for rewards are commonly referred to as rewards-based crowdfunding and the type of crowdfunding discussed in the article.  

Rewards-based crowdfunding is the most common means for getting small amounts of money from a large group of people to fund a project. Campaigns seen on Kickstarter, Indiegogo, Crowdrise, Patreon and other platforms where rewards are given to backers instead of ownership interest are what most people tend to associate with the term "crowdfunding."

But is crowdfunding a right fit for your business? Here are some factors that you need to consider before launching a Kickstarter campaign or looking to other platforms as it carries a great deal of risks and benefits.

How Much Money Do You Need?

This is one of the foremost issues with rewards-based crowdfunding. Campaign creators have a double-edged sword because if it looks like they are asking for too much money, potential backers will worry that they won't reach the funding goal and this can stop them from backing. Conversely, setting the goal for an insufficient amount inverts the problem since the creator is now obligated to create and deliver a project they will lack the funds to complete.

In addition to Kickstarter and Stripe fees (5 percent and 3-5 percent, respectively), reward fulfillment is the next major expense aside from the actual costs of completing your project. Unlike, a campaign for personal purposes which are gifts made out of a detached generosity or to raise equity in return for ownership, both of which are non-taxable, funds raised through rewards-based crowdfunding are taxable to the extent they exceed your fundraising expenses.  In some states, you will owe sales tax, which creates extra administrative costs. These expenses can take an unpleasant bite out of what you raised.

And this hasn't even factored in the expenses associated with setting up the campaign in the first place, such as graphics, public relations assistance, video production, copywriting and all of the time involved in preparing for and running the campaign.

What Do You Need the Funding For?

Are you looking to start a new project from the ground up? From seed money? From a little ongoing income to cover your living expenses while you work on your business or project?

This will determine the type of platform to use: Kickstarter is more project based; Indiegogo is more lax about the type of campaigns it allows; and Patreon is more like a salary, whereas the former two companies are more akin to getting seed money. Another consideration is whether crowdfunding is really appropriate for your project at all.

Your needs for funding should provide some kind of explicit or intrinsic value to your backers. If you're a game developer making a sequel that offers a chance for the backers to get involved, you're going to have more success in crowdfunding than with an e-commerce startup seeking a small amount of money to upgrade its equipment. With the higher standard that crowdfunding campaigns are held to today, potential backers also want to see if you've invested time and money into your project before they part with their cash.

What Type of Following Do You Have?

This is really the most dire determinant as to whether or not crowdfunding is right for you: Do you have some kind of following with your startup's current incarnation or perhaps from a previous company or hobby? Because crowdfunding has become so much more common in recent years, unless your campaign is for an incredibly mind-blowing invention, you're going to have a very hard time without some kind of pre-existing following.

Getting press from reputable outlets or a lot of retweets and likes isn't enough. You need highly engaged backers who have an emotional investment in seeing you succeed. This doesn't happen as a result of convincing them that you'll be profitable or that your project is great. They need to be familiar with you and your work over time.

All in all, crowdfunding can be an excellent way to validate demand for a new product, or simply as a publicity effort. It can also be an extremely expensive way to raise money and put a massive strain on your resources, which you may want to avoid if you don't have a lot of working capital or a significant enough following yet. Compared to more traditional methods, such as lending, outside investment and using your own money, a successful campaign can also bring about unwanted tax consequences. However, crowdfunding is still fantastic for discoverability and can be worth pursuing.

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Sherri Hastings

Sherri Hastings

Tim Murphy is the managing member at Murphy & Murphy, CPA, LLC, a full-service certified public accounting firm, with emphasis on tax preparation, audits of governmental, educational, and non-profit entities, retirement planning, estate planning, business valuations, litigation support, and banking. He is a Certified Public Accountant in Maryland and Virginia. Tim is also a CERTIFIED FINANCIAL PLANNER professional, Personal Financial Specialist, Accredited Estate Planner, Certified Valuation Analyst, and Investment Adviser Representative.

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