Free Enterprise - The FindLaw Small Business Law Blog

Fun With Crowdfunding, Legally Speaking

You've got a great idea, and you're sure it's going to make it big! Now all you need is money, quite a bit more than you're willing to personally invest, to give this project some legs. Before you start blasting your friends on social media to announce your latest rewards-based crowdfunding project, here are a few things to consider before posting that Kickstarter campaign.

This Is a Contract

Generally speaking, an enforceable contract exists when there is an offer, acceptance, consideration, and an intention to create a legal relationship. In most rewards-based crowdfunding campaigns, all four exist, such as in the form: "Thank you for joining this crowdfunding campaign for Bluefish Crackers. If we meet our crowdfunding goal, in exchange for your $20 backing, I will give you a box of Bluefish Crackers from the first run of production!" All four elements of a contract exist here. If you take that $20 and hit your crowdfunding goal, you may have to get that person a box of Bluefish Crackers in the coming years, or they can ask for their money back if you can't deliver the promised reward. $20 may not seem like a big deal. But what if 1,000 people are asking for their $20 back. At $20,000, you may have a problem! Your best bet might be to offer a reward that is as easy to deliver on as possible. Keep that bar low!

Fraud and Consumer Protection

In addition to breach of contract, consumer fraud may also be an issue, especially if you fail to deliver. To prove consumer fraud, a backer must show that you had intent to deceive, knowledge of the falsity, and they had the right to rely on the falsity. Although it is very tempting to puff your project in hopes of garnering backers, everything posted on the crowdfunding website must be honest and true, to the best of your knowledge. Everyone likes to please, but it's best to not overpromise on what you can deliver.

Similarly, backers may make a claim for false advertising. Be realistic with backers about what the product currently does and what the future product will, and will not, be able to do. Be sure to know where the line is between aspiration and fraudulence. Mistakes can be costly, and can even criminal.

Did You Add in the Tax?

All funding coming from reward-based backers is taxable. Repeat: All funding coming from backers is taxable. Unlike other forms of investment, reward-based crowdfunding must label these funds as revenue. On your tax return, you can itemize deductions for costs incurred that same year. But it gets complicated if you plan on capitalizing and amortizing costs. The bottom line is: this money is taxable. Save some for Uncle Sam. And please don't think that you can fudge backer-funding figures. Most crowdfunding companies use PayPal or Amazon as a third-party processor to bridge the financial arrangement between the backer and creator. Those firms most definitely comply with the U.S. Patriot Act, and both work with the IRS. If a creator collects over $20,000 and has 200 transactions a year, they will receive a Form 1099-K, reporting these revenues. So there's no escaping taxes.

As you can see, a lot of thought should go into that crowdfunding posting. Note that rewards-based funding is handled very differently than equity-based and donation-based crowdfunding, in the eyes of the law. If you are thinking about kickstarting your own crowdfund, contact a local corporate attorney who can best assess your situation, and provide you with valuable legal advice.

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