October 23, 2014

Handling the Risks Associated with Raising Money on Kickstarter

raising money on kickstarter

For young companies, crowdfunding can seem like easy money that will let them build the business they’ve always dreamed about. So far, more than 49,000 projects have been funded on Kickstarter to the tune of $821 million.  But there are risks associated with raising money on Kickstarter and similar sites.

Compared to applying for other funding sources, it’s relatively quick and simple to post a pitch on a crowdfunding site like Kickstarter to see what happens. But this faster pace often means that people looking for funds are less likely to consider some important aspects of running a business.

Raising Money on Kickstarter: Liability and Tax Issues

Liability

While you may not be dealing with the same amount of contracts and paperwork as you would with a traditional lender, raising money on Kickstarter is still serious business. You may not be dealing with a banker or VC (venture capital) firm, but with crowdfunding, you’re actually dealing with tens, hundreds, even thousands of investors.

A lot of the time, crowdfunding seems like a platform where startups take pre-orders from customers for a not-yet-finished product. And that dynamic always carries risks.

For example, CNN Money reported that:

  • 84% of the top 50 funded projects on Kickstarter in 2012 shipped late.
  • More than 75% of hardware projects on Kickstarter fail.

When backers are excited to get their product, any delays will only disappoint and frustrate them.

Obviously, no one starts a crowdfunding campaign to fail or weasel people out of money. However, any time you’re making something, whether it’s a tech product or something creative, you can’t always plan how things will work out. And, unfortunately, not every project will work out.

Precautions to Take in Advance

So, what does that mean for you?

If you want to launch a fundraising campaign on Kickstarter or any other crowdfunding site, you should take the following steps before you post your project:

1. Form a Legal Business Structure, Like an LLC or Corporation

This will give you a layer of protection that can help shield your personal property/assets/finances from your business. If something happens to your project, it means that the business is liable, not you personally.

Remember, you need to have the LLC or corporation officially established before starting the crowdfunding process. All contracts and forms should be done through the LLC and corporation (and not signed by you as an individual).

Get an EIN (Employer Identification Number) After Your LLC/Corporation is Formed

If you’re not familiar with an EIN, it’s essentially a social security number for your business and you’ll need it to open your business’ bank account.

Open a Business Bank Account

Once you have an EIN, your LLC/corporation can open its own bank account. This is going to be an important step to making sure your personal and business finances stay separate.

Taxes

The tax implications of crowdfunding can catch people off guard if they don’t do a little homework beforehand. When people raise money through traditional sources, those funds are considered “contribution to capital.” That means they’re usually not taxed.

However, whenever you raise money on Kickstarter, those funds are considered income. You’ll most likely be issued a 1099-K.

If you bring in a lot of income from crowdfunding, you’ll most likely want to offset it with deductible expenses. Most likely, if you’re starting/finishing your project, you will have expenses. The problem occurs when your Kickstarter funds fall in a different tax year than your expenses.

For example, let’s say you receive your Kickstarter funds in November, but then you don’t actually dive into the project and start spending until January of the following year.

To address this issue, you have two options:

  • You can strategically schedule when you’re going to raise/receive funds and when you’ll be incurring the bulk of your expenses.
  • You can opt for a C Corporation structure, which gives you more flexibility to define your fiscal year for tax reporting (i.e. maybe your fiscal year is April to April). In this case, you should probably turn to a professional tax advisor or accountant to really understand all the implications.

The bottom line is that you need to approach Kickstarter or any other crowdfunding campaign as a traditionally funded business. It’s not a side project or hobby and all of the normal business rules apply.

Money Photo via Shutterstock

9 Comments ▼

Nellie Akalp


Nellie Akalp Nellie Akalp is CEO of CorpNet, her second incorporation filing service based on her strong passion to assist small business owners and entrepreneurs in starting their business. Free guides, advice and videos on small business legal topics are available at her Small Biz Corner.

9 Reactions

  1. While I know the power of crowdfunding, it is still quite risky if you’ll ask me. Don’t get me wrong though. I know that it is a good option for people who are just setting up their business given the fact that they can easily recover the capital. But as you said, it will never be free of risks.

  2. I’ve been in commercial bank leveraged investments. The advantage to crowdfunding is you will be lent the money by the backers temporarily, and if successful start relatively debt free. This without the “lender” laying hold of or placing a lien on any and all assets you have before lending you anything. If you’re have no access to powerful assets- you never will get a business start loan from a commercial bank- period. If you have these assets and your startup fails- you are going to loose these assets- ever lost 400k? I have = it’s no fun.

  3. In any money raising venture like Kickstarter, there will always be a measure of risks associated with it. There is no free lunch here and you have to give something back to the investors such as e-book if you plan to publish a book.

  4. There was a Kickstarter campaign in Toronto awhile ago to raise money for a non-existent video tape of the mayor doing drugs. There was almost $200K raised I think and when the deal fell apart, the people ended up giving the money to different charities. I didn’t agree with it since that’s not what the money was donated for.

  5. And I thought it was just free money ;)

    Great points to consider BEFORE getting your Kickstarter campaign going.

  6. Nellie,

    Don’t forget about copyrights issue. When you launch a project on Kickstarter, beware that there are opportunists out there who keep their eyes on you and your products.

    You simply don’t want to raise $200K only to get yourself on a legal battle.

  7. Young companies see crowd funding an easy way to build their business but there are some risks associated with it like on Kick-starter and similar sites and these issues are liability and tax.
    • In crowd funding you are dealing with thousands of investors and it is a platform where start-ups take pre-orders from customers for not yet finished products which always carry risk and delays will only disappoint customers.
    • Tax implications of crowd funding can catch people off guard if they do not do a little homework beforehand.
    The bottom line is that you need to approach Kick-starter or any other crowd funding campaign as a traditionally funded business rules apply.

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