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Potential Pitfalls Of Crowdsourced Funding: What Every Founder Needs To Think About



15 years ago, classrooms and boardrooms were a buzz with the internet’s potential for democratizing pretty much everything. Even back then it was clear that the web was going to be a major game changer in how everything from political systems to the economy would run. Flash forward, and sites like Kickstarter have introduced a way for people with great ideas to secure crucial funding, to get “the next big thing” off the ground and into the public’s living rooms and laptops.


For obvious reasons, many startup founders are attracted to the idea of avoiding banks and venture capitalists, but financing your project through crowdsourced funding is not a risk free option. If the idea is to acquire capital for a money making endeavor, rather than funding a hobby, some practical details need to be worked out prior to going live with crowdsourced funding.




Limit Your Liability

This is probably the most important thing to consider when starting a project, is that in addition to investing your own money, you are also opening yourself up to being legally liable for this new enterprise. Before you start accepting people’s money you need to legally distance yourself, so that your personal assets are protected. It might sound callous, but even the most upstanding startup founder needs to realize that they are liable to both their investors and the IRS, so seeking legal protection is key.


The most basic way of doing this is by establishing this startup idea as a LLC (Limited Liability Company), which essentially transforms your startup into a legal entity that allows profit to go directly to you, with the understand that you are responsible for the taxes but not personally liable for the actions or debits of your company. There are many cost effective methods for drawing up an operating agreement, which is what you will need to make this process official.


The operating agreement will also spell out the legal parameters you need to stay within if you want to maintain legal standing liability protection. It also allows you to file for an employer ID number with the IRS and open up a business account under the company’s name. Both are key in establishing the legal separation between you and the business. It will also make things a lot easier for your tax guy come tax season.


Stay On Top Of Taxes

Even though money that gets raised through sites like Kickstarter are considered “donations,” there are still some tax laws that apply. Crowdfunding websites cannot offer tax advice, but most will have information for accountants to help when submitting paperwork to the IRS. In addition to talking to your tax guy or girl, you should be aware that even though you can offset the money you receive in donations by spending  the money on your business (i.e if you get 5K in donations and can prove you spent 5K on business related costs you’re in the clear) things get a bit more complicated if you spend the money you receive in a different fiscal year than when you originally received it.


Also keep in mind that anytime 20 thousand dollars or more gets processed (through donations, selling, etc.) a 1099-K form needs to be filled out. This is just one example of why, finding a good tax specialist is a key part in the formative phases of your project.




Protect Your Idea

Taxes aren’t the only hurdle facing creators while they try to get their project going. Using a crowdfunding platform doesn’t just bring your idea to potential investors, it can also bring it to your competition’s attention. The Copyright Act explicitly outlaws the protection of an idea through copyrighting, but there are still ways of protecting your intellectual capital in other ways, so get in touch with a lawyer who is familiar with the needs of startup companies.


Keep Communication With Investors A Priority

Keeping the people behind the funding of your project posted is crucial at almost every stage of your projects development. Maintaining communication helps to keep them excited, but should also be seen as an opportunity to let them in on the process, which can help you keep your delivery date flexible. In addition to not making promises you can’t keep, you need to communicate that the time line for your project is context driven, and subject to change. Keeping a dialogue going with your project’s “public” gives you some wiggle-room and helps them feel more personally invested it the process.


Staying away from venture capitalists and big banks is a noble goal, but it still comes at a cost. The right support team attention to detail should help you to mitigate these risks, and hopefully get you to a place where you can reap the rewards new funding sources have to offer.


Photo Credits

bplanet | Arvind Balaraman | 

Author : Adam Corl

Adam Corl is a New England native with a passion for sarcasm, wine that tastes expensive, and keeping his parents questioning his life choices. This combined with a keen interest in organizational behavior and social science research has lead him to fund his nomadic lifestyle through freelance writing and research endeavors. When he is not writing about bootstrapping magic and project management tools you can find his stuff at The Bubble, where he is a staff writer.

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