Jason M. Tyra, CPA, PLLC provides review, and consulting services to small businesses, startups and entrepreneurs preparing for early stage fundraising. If you aren’t sure whether crowdfunding is for you, check out the Founder’s Guide to Startup Funding, hosted by StartEngine.
About Crowdfunding
Crowdfunding is a way that entrepreneurs, startups, and small businesses can use the internet to harness the collective knowledge and resources of whole communities of people in order to raise capital. This is a brief overview of the different types of crowdfunding and is meant neither to be an exhaustive survey of this financing option or to provide business or legal advice in itself.
There are two basic types of crowdfund projects – affinity crowdfunding and equity crowdfunding. Each offers a unique set of benefits and challenges to startups and small businesses. Both should be carefully considered before pursuing as a means of generating capital.
Affinity Crowdfunding
Affinity crowdfunding involves raising funds in exchange for a tangible benefit other than an ownership interest in a venture. Kickstarter is an example of a venue for affinity crowdfunding. The benefit derived from participating in this kind of “investment” is usually purchase of a product or service before it is commercially available, such as the Pebble smart watch, but can also be something of negligible value or even nothing at all. Consumer goods, independent films, theater productions, art installations, charities, environmental initiatives, and a wide variety of other projects have all successfully funded themselves using affinity crowdfunding.
Affinity crowdfunding offers significant benefits for entrepreneurs, but also creates a few challenges. First, websites like Kickstarter provide very low risk access to capital without having to take on new investors or debt. However, crowdfunding websites usually do not subject business plans to the same level of scrutiny as a commercial bank or institutional investor might.
The ability to pre-sell a manufactured product before it has even been commercially prototyped can be just what a startup needs in order to bridge the gap between concept and market. However, these same companies often become victims of their own success when they discover that mass manufacturing a very popular or technically complex product is more difficult or expensive than projected. The crowdfunding campaign might generate enough funds to “close”, but not enough to accomplish its objective, leaving it doomed to fail from the start.
Many campaigns deliver to their backers much later than projected or worse- never. Backers, in response, have little recourse other than to complain loudly and publicly, damaging the reputation of a company that might have a solid product or service and good intentions, but not enough money to make deliver what was promised.
Unlike equity offerings, affinity campaigns that offer pre-sales of products or services are usually subject to income taxes at the state and federal level. Those rules and other helpful tips are discussed on the IRS website here.
Equity Crowdfunding
Equity crowdfunding is the second type of crowdfunding. Though the private placement of unregistered securities is legal, subject to certain restrictions, under Regulation D of the Securities Act of 1933, advertising of such offerings was not permitted by the SEC until very recently. The Jumpstart our Business Startups (JOBS) Act established an exemption from registration, subject to certain restrictions, for use of registered internet portals for solicitations to sell securities to non-accredited investors.
The JOBS Act lowers the barriers to entry for startups and small businesses looking to “go public”, allowing them to use the affinity crowdfunding model to raise capital by selling equity to investors all over the country. Further, it grants smaller investors the opportunity to access offerings that have traditionally been open only to venture capitalists and other wealthy investors. However, companies that employ this option must understand that they are taking on investors who are legally part owners, along with all of the attendant pitfalls and complications.
Equity campaigns must be very carefully planned and structured not only to ensure that they comply with the law, but also to prevent unintended and unforeseen consequences (such as a takeover of your company by disgruntled shareholders).
When carefully considered, planned, and executed, crowdfunding can be an effective and low risk way to raise capital. Jason M. Tyra, CPA can help you select a funding portal, prepare for your affinity or equity crowdfunding campaign, and provide additional accounting and tax and legal services to support and help you keep your promises to your backers or your investors.
Contact us to learn more about how we can help your company succeed.