Crowdfunding is a powerful method for digital fundraising that provides a valuable opportunity to gather financial support from a variety of sources. Since the concept first took off over a decade ago, participation has skyrocketed. Top crowdfunding site, Kickstarter, for example, reported total pledges of $4,787,016,823 as of February 2020. This is only the beginning: data from Fundly suggests that the market will reach $300 billion by 2025.
Inspirational tales of crowdfunding success abound. PopSockets, for example, owes its success to a groundbreaking Kickstarter campaign. Likewise, Oculus VR raised an impressive $2.4 million via crowdfunding. These results were sparked, in part, by the company’s generous offer of “dev kit” editions of the Oculus Rift in exchange for sizable contributions. This wildly successful campaign demonstrated the potential of crowdfunding as an alternative strategy for gaining critical financial support.
Crowdfunding for small businesses: opportunities and obstacles
Most people agree that crowdfunding benefits society by allowing small businesses to gain the resources and exposure they need. Othersare concerned about the legality of the practice, which remains poorly regulated. Murky legislation and limited oversight may prompt potentially generous contributors to back away from promising campaigns.
At the business level, crowdfunding concerns largely involve compliance issues. While this fundraising method can prove lucrative for startups seeking quick cash infusions, they shouldn’t approach it haphazardly. Different issues may arise depending on the type of campaign, but the following crowdfunding legal concerns are especially common.
The potential for personal liability
Crowdfunding platforms make every effort to avoid liability. This leaves organizations or individuals seeking support at risk, especially if funding secured through crowdfunding sites is processed through a personal account. In most cases, it’s advisable to set up a business entity as an LLC rather than to remain a sole proprietor by default. Following small business formation, payments can be processed on an official basis. This limits the potential for personal liability.
Intellectual property disputes
Marketing for crowdfunding campaigns often involves photos or videos, which may include footage or music that campaigners are not actually permitted to use. Individuals or organizations should carefully vet potentially problematic intellectual property to determine whether such material is permissible under fair use—or whether they should contact artists to make licensing arrangements. Names and slogans should also be researched thoroughly.
On the flip side, crowdfunding efforts can increase the potential for others to discover and use a campaign’s key concepts without permission. For this reason, it’s worthwhile to seek necessary copyrights or patents prior to embarking on ambitious crowdfunding efforts.
The IRS deems all monetary gains from crowdfunding as income, not gifts. Taxes must be paid on all funds obtained through these campaigns. PayPal and other payment processors typically send an IRS Form 1099-K as soon as campaigns reach 200 transactions and $20,000 in gross income. If secured funding falls below this threshold or is handled without the use of a major payment processor, it must still be reported to the IRS.
Equity crowdfunding concerns
Early approaches to crowdfunding largely involved product pre-sales. They were therefore not regarded as investments in the eyes of the Securities and Exchange Commission (SEC). More recently, however, equity crowdfunding efforts sparked by the Jumpstart Our Business Startups (JOBS) Act have prompted greater involvement from the SEC. Exemptions from federal security law may occur with the following stipulations:
- Crowdfunding organizations are permitted to raise up to $1 million within a 12-month period.
- Individual contributions are capped based on investors’ income or net worth, with a total limit of $100,000 applied to all campaigns within a 12-month period.
- Exemptions do not apply to companies based outside of the United States.
Organizations that pursue exemptions must file detailed offering statements, progress updates, and annual reports. Significant limits still apply for advertising campaigns related to crowdfunding efforts.
How to protect yourself and your business
Your eagerness to follow in the footsteps of PopSockets and Oculus VR is understandable, but caution is critical when dealing with the risky world of crowdfunding. Thankfully, numerous options are available for protecting your concept and your finances.
As previously mentioned, business formation is a critical first step. From there, work with an attorney to secure your intellectual property and avoid inadvertently infringing on somebody else’s copyright.
With due diligence, it is possible to harness the benefits of crowdfunding without sparking legal drama. Before getting caught up in the excitement of this potentially profitable approach, take some time to thoroughly examine the legal implications and seek assistance as needed. This effort could save you a lot of grief down the road.