Fund-Raising for the Facebook Generation 

Crowd-funding sites help entrepreneurs kick-start their businesses, but are these new platforms too good to be true?

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Kickstarter, which is based in Brooklyn, didn't respond to any of this reporter's inquiries. But IndieGoGo's Danae Ringelmann says those who worry about crowd-funding fraud are ultimately making some specious assumptions about human behavior. She says her staff always coaches clients, as they're coming up with their fund-raising plan, to start off by reaching out to their inner circle — their friends and family members.

"So if you're someone who's trying to commit fraud, and you have no track record of anything you've ever done, and you're just trying to get money from random strangers, and you don't market it all to your core base, so that there's no money coming in from that, you're not going to raise money," Ringelmann said. "That's just the mechanics."

She explains that when the company first launched, they actually implemented a ratings system similar to what's used on sites like eBay, but they got rid of it because no one ever used it. The transparency of the crowd-funding process — the fact that all the information about a particular project is right there for you to see online, and stays there even after the project has been completed — is enough of a fraud deterrent. In other words, if you don't feel that a project offers enough information or assurances, you're under no obligation to give any money.


Ultimately, Lawton agrees that the transparency of the process greatly reduces the risk of fraud — where he differs is in his desire to increase that transparency, especially in that post-funding period, by including things like a rating system and increased documentation to show exactly what's being done with the money. When you're talking about $5 or $10 and a movie ticket or a CD, the stakes are relatively low. But things certainly change when you start talking about tens or hundreds of thousands of dollars — which Lawton believes become more prevalent as crowd-funding solidifies itself as the mechanism of choice for businesses that want to raise money.

Another source of confusion is the issue of how the money that an individual or a company raises through crowd-funding ought to be treated from a taxation standpoint. Should the money be treated as a tax-exempt donation? (Certainly not, unless the organization raising the funds has nonprofit status.) Should it be treated as income? Or, if you're pre-selling merchandise, is it considered a sale?

IndieGoGo advises campaign owners to consult their own tax attorney, noting, wisely, that what taxes they owe will vary widely depending on their location and the individual circumstances of their project. That said, taxation does appear to be yet another factor that aspiring entrepreneurs may not consider when deciding whether or not to use a crowd-funding site. Indeed, the successful crowd-funders interviewed for this story expressed their intent to pay taxes, but several were unsure of how exactly they ought to file.

UC Berkeley law professor Eric Rakowski is a tax law expert, though he gives the caveat that he hasn't investigated the issue of crowd-funding specifically. That said, he says there are some basic principles at play here, having largely to do with the motivation of the donor in each specific case. Rakowski said that if the donor is motivated by what the Supreme Court has termed "disinterested generosity," then the money can simply be treated as a gift and isn't subject to taxation. But if some tangible perk is given in exchange for the contribution, then that transaction can no longer be viewed as a pure "donation," per se, from a tax standpoint. In some instances, the perk is just a token payment — a T-shirt, let's say — in which case, Rakowski speculates, the bulk of the transaction can still be treated as a tax-exempt gift. Only the value of the T-shirt itself would count as taxable income.

But often, businesses and individuals are essentially using the crowd-funding platform to pre-sell merchandise, usually even at a discounted rate. In that case, Rakowski doesn't see any way of getting around the fact that these crowd-funding beneficiaries would owe state and local sales tax on the full value of whatever it is they're selling. If true, it would be another big chunk of money that would be taken out of the $15,000 or $50,000 that might have been raised — and that's on top of the cut taken by the crowd-funding site, and on top of whatever cut Paypal or the credit card companies are taking. When all is said and done, a business might easily lose 20 percent of the total sum that gets pledged — especially since many project owners don't appear to be adjusting their pledge increments to pass any of these costs, like the sales tax, on to potential donors.

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