With inflation and rising interest rates, organizations need as much capital as possible to stay afloat. Due to the proliferation of options on the internet, raising capital has never been easier. Organizations can stay in front of their customers by engaging in crowdfunding.
This new phenomenon solicits contributions from a pool of people over the internet. Here is an example of how a business—in this case, a physician who owns his practice—might use crowdfunding: Dr. John is a cardiologist looking to purchase medical equipment that costs $325,000; he could start a business crowdfunding campaign and solicit the public to help purchase this equipment. Examples of websites he can use for his campaign include Fundable, GoFundMe, and Chuffed. Crowdfunding could help him accomplish two goals: 1) keep the practice relevant to his patients, and 2) help raise additional capital for the purchase of equipment. The visibility and relevance to his patients and the public could have positive unintended consequences, such as attracting new patients without any marketing expense.
Types of Business Crowdfunding
For organizations, there are two methods of crowdfunding: reward-based crowdfunding or equity-based crowdfunding. Reward-based funding offers campaign donors some type of gift, like a shirt or mug, for their contributions. With equity-based crowdfunding, donors do not receive goods or services; however, they receive a financial stake in the company. It is important to note that this type of funding is regulated heavily by the Securities and Exchange Commission (SEC). Typically, businesses that resort to this method are startups and new to the industry.
Platforms such as Fundable, WeFunder, or Chuffed will send a business a Form 1099-K, Payment Card and Third-Party Network Transactions. The business will use the form for tax reporting purposes; however, it does not determine whether the full amount is taxable or not. That is determined by the nature and source of the funding.
The tax ramifications of crowdfunding depend on the type of business reward used. For reward-based funding, a donor receives goods or services in exchange for his or her donation, so the income is taxable to the business. The business would include the income on its tax return and net against any business expenses associated with the funding.
For equity-based funding, a donor does not receive a good or service; instead he or she receives a financial stake in the organization. Because the donor received a financial stake and not goods or services, the IRS has deemed this a capital contribution or otherwise an investment in the business. The contributions are not taxable income for the business. The Securities and Exchange Commission allows a private business to raise a maximum of $5 million in equity crowdfunding per year. The SEC also limits how much non-accredited investors can invest in crowdfunding offerings over a 12-month period based on their annual income and net worth.
Finding ways to stay in front of customers and generate more capital can help your business long-term. Crowdfunding may help your business stay relevant, purchase cutting-edge equipment, and generate more revenue.
If you would like more information about crowdfunding and how it may affect you or your business, or if you need guidance related to any business advisory, tax planning and/or strategy matter, one of our executive contacts would be happy to assist. You may email them below or call (800) 270-9629.