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Crowdfunding is a popular way of raising money for all sorts of causes, as well as being an increasingly common option for businesses in need of funding to test ideas and launch businesses. In this article we’ll explain how businesses use crowdfunding, and what this means for paying tax on any funds you raise.

What is crowdfunding?

Crowdfunding relies on getting many small investments from a bigger group of people, rather than a single large amount from one source.

Crowd funders typically attract people to causes that they care about or have an affinity with. For example, they may get together to fund a medical research project, or a business that wants to manufacture certain goods, or even donate cash to build local facilities.

The wide reach of online funding platforms means that people from all over the world can take part in a particular crowdfunding project.

What are crowdfunding platforms?

Crowdfunding platforms are a bit like an online marketplace, such as Amazon or Etsy, but for fundraising. An individual or organisation can use the platform to create a page for a project which needs funding, and the platform then publicises the campaign to its subscribers. In most cases the platform also manages and collects any bids or donations the campaign receives.

There are a range of crowdfunding platforms available, all with their own rules, requirements and terminology. For example, one platform will refer to crowdfunder as a ‘project’, whilst another may use the term ’cause’.

Some platforms are more suited to one type of fundraising project than another (which we’ll get to next), but they’re essentially doing the same thing by making it possible for a crowd of individuals to support a particular goal.

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What are the different types of crowdfunding?

Crowdfunding methods vary, from offering rewards to those who invest in startups, to relying on goodwill for charitable donations. Many platforms will specialise in a particular type of crowdfunding so there’s lots of choice, although they tend to fall into one of a few main categories.

Gifting crowdfunding

Gifting crowdfunding is arguably the first and most well-known form of crowdfunding. These campaigns might take the form of:

  • A charity asking for donations to complete a particular project or deliver a specific service
  • Someone might do a sponsored run in someone’s memory, and ask for donations to a charity
  • A school raising funds in order to buy new gym equipment
  • A business that has designed a new product, and wants to develop a prototype for testing

GoFundMe and JustGiving are typical examples of platforms that work for charities, while Kickstarter is a platform which typically supports creative arts projects.

Loan crowdfunding

Taking out a business loan normally involves a single lender, such as the bank, but with loan crowdfunding the money comes from a group.

Like most types of loan application, you’re more likely to get the funding you’re after if you can explain what the money will be used for.

For example, a restaurant business that wants to open a new site might need cash to pay for the fitting out. Similarly, a retail business may want to invest in stock, or a manufacturer in new machinery.

Kiva is a platform that works with charities to advance micro-loans to people in disadvantaged situations. For businesses there is (amongst others) FundingCircle, which advances loans to businesses looking to expand.

As with normal loans, the business pays back a proportion of the advance each month, along with an interest charge. The crowdfunding site distributes this to the individual investors.

The benefit to the business is that crowdfunding can raise finance quickly, and often when it would be unable to do so from a high-street bank. The investors get a good return on their money but as with all things, there is a risk of non-payment and bad debt.

Equity crowdfunding

In simple terms, equity is the value of a business, and this value is split up between the people who own it – known as shareholders. Equity crowdfunding is where a group of people band together to buy a proportion of the shares in a business.

These might be standard ordinary shares, or a special class devised purely for the crowdfunding project. In return, the new shareholders might:

  • Receive dividend payments. These payments are made from any profits the company makes, based on the proportion of shares you own. More profits means a bigger payment!
  • Have the opportunity to sell the shares at a later date, hopefully for more money than they paid

This type of crowdfunding campaign might simply be an investment vehicle for the investors, but it can also be a way of supporting worthwhile businesses, especially through the start-up and early growth phases.

Examples of equity crowdfunding platforms include Seedrs, and Crowdcube. The business benefits not only from the incoming investment, but also from a boost to its profile through the funding process.

Crowdfunding incentives

People get involved in crowdfunding campaigns for all sorts of reasons, from the prospect of earning interest income from loans, to receiving dividends as a result of owning shares. Creators and innovators might offer subscriptions, artwork, free samples, or discounts on future purchases.

Some campaigns offer incentives in tiers to encourage larger investments.

For example, an artist offering stickers for small investments, and signed original artwork for larger ones. Charity crowdfunding tends to have a simpler incentive, in that you are helping other people in an area that you care about.

Things to consider before crowdfunding

Whether or not you decide to try crowdfunding for your business depends, like most decisions, on your circumstances.

Do you have the time for a crowdfunding campaign?

Crowdfunding takes a lot of time and effort, especially if you’re looking for equity investors (who usually want to know a lot more about what they’re getting involved in). Don’t underestimate how much time you’ll devote to setting up your project.

You’ll also need to produce regular updates, both as the campaign progresses, and afterwards when you show what the fundraising is being used for.

Can your business service the loans?

If you take a crowdfunded loan then you’ll have monthly repayments to meet. Can your business service them? If not, then you shouldn’t proceed.

Do you have a business plan?

Whether you are looking for equity or loan finance, you will need to have a business plan prepared to a high standard, showing what difference the investment will make to your enterprise.

Do you have a compelling offer?

Investors want to put their money with businesses that have something to say. If you are looking for equity investment, then you’ll need to show how you are different to similar competitors, and why you will succeed.

For loan investments, you can explain how the loan will improve your business, (which will, in turn, make repaying the loan easier).

What are the fees?

Before you sign anything, make sure you know exactly what the crowdfunding platform is going to charge you. Some platforms charge the business, some charge the investor, and many charge both!

Don’t forget to add in the costs of any consultancy or professional help you need to put together your offer.

Will I pay tax on money I crowdfund for my business?

When we look at tax and crowdfunding, we have to think about it from both sides; the business, and the investor who (maybe) receives a reward.

A business receiving funds from crowdfunding will normally pay tax on the amount, just like it would on any other type of income.

The exception to this is if it’s a loan which needs to be repaid.

If it’s a loan you’ll also be able to claim the cost of paying interest on the repayments as an allowable expense.

Any income you receive as a result of investing in a crowdfunding campaign will also be treated in the same way as any other type of income. For example, if you put money into a crowdfunded loan and then later receive interest on top of the repayments, then the interest (and not the repayment) is income, and therefore taxable.

If you buy shares then you may need to pay Capital Gains Tax on any increase in the share value when you sell, or pay dividend tax on dividends.

Crowdfunding can transform a business, but it’s important to plan carefully, and understand the tax implications. Learn more about our online accounting services. Call the team on 020 3355 4047, and get an instant online quote.

About The Author

Elizabeth Hughes

A content writer specialising in business, finance, software, and beyond. I'm a wordsmith with a penchant for puns and making complex subjects accessible. Learn more about Elizabeth.

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