Crowdfunding is quite literally what the name suggests – a way of raising funds through a crowd of people. The idea is that rather than receiving a large amount from a single source, the business raises lots of smaller amounts, but from more people.
A crowdfunding campaign often focuses on a particular product or service. For instance, raising money to fund the manufacture of a new product, or to rent a location for a particular service.
There’s often an incentive to encourage backers, and this can vary wildly. Ranging from handwritten notes, early access to the product once it’s made, or mentions on social media, incentives can even include a share of the profits.
An example of business crowdfunding
A successful mobile dog grooming service has grown to the point where it now needs the deposit for a business premises to expand its operations. Rather than going to the bank, the business owners set up a campaign on Kickstarter, a popular crowdfunding platform, to raise the money they need.
The owners circulate the campaign around their personal and professional networks to raise awareness and attract donations. They also promote the campaign through the local newspaper and social media groups with a local focus.
To encourage more backers, they offer a discount on services to those who donate over a certain amount. The discount is offered on the basis that it’s used within a particular timeframe, and only if the campaign reaches its target. (And that’s an important point that we’ll come back to).
The benefits of crowdfunding for a growing business
In short, crowdfunding helps businesses access funding from friends, family, professional connections, and the wider public, rather than financing through bank loans or investors. There are several advantages to this, such as:
- Avoiding the headache of applying for traditional bank loans (as well as the pressure of repayments).
- Negating the often stressful and time-consuming process of pitching to investors.
- Enabling friends, family and other people who care about the business, owner, or both, to contribute to its growth.
- Minimal upfront fees or ongoing costs, which also means significantly less risk. Crowdfunding platforms typically take a percentage of what you raise.
- It can be a great way to get your product or service in front of more eyes. Lots of backers go on crowdfunding sites actively looking for businesses or projects to support…
- …which means it’s also an effective way to gauge interest in what you’re offering and the appetite for your product or service in the market.
Just be aware that some crowdfunding platforms have rules which mean if you don’t hit your fundraising target, all the money is returned to the backers. Check the terms and conditions before you start!
Do you have to pay tax on money raised through crowdfunding?
Although the money you raise through crowdfunding might feel like extremely generous donations, that’s sadly not quite how HMRC see it. Crowdfunded money might feel like free cash but in the eyes of the law, it isn’t – nor is it a loan or a donation.
This means you must report any money you receive through a crowdfunding campaign because HMRC usually classes it as taxable business income. How you do this depends on whether you’re set up as a limited company or a self-employed sole trader.
- As a limited company you will need to record any crowdfunding income on your Company Tax Return and pay Corporation Tax.
- If you are a sole trader, you will need to record it on your Self Assessment submission and pay any income tax due.
This is relatively simple, but things can start to get a little more complicated when Value Added Tax (VAT) is added into the mix.
Do I need to pay VAT on crowdfunding income?
The reason things become a bit more complex where VAT is concerned is dictated by the kind of incentive you offer in exchange for crowdfunding investment.
Some incentives have an intrinsic value, such as merchandise or an exclusive product, whilst others have symbolic value, such as a mention in a blog or on social media. If the reward has an intrinsic value, then there’s a ‘supply’ for VAT purposes.
When the money is an advance payment
If you offer a physical reward (such as merchandise) in exchange for backing, the money you raise is classed as an advance payment. For VAT-registered businesses, this means that the crowdfunded money is part of your VAT taxable income, and is included in your VAT calculation.
When the money is considered a donation
If someone donates without the expectation of a reward, then it’s not subject to VAT. Likewise, if the incentive that you offer has a symbolic value. So, if you put on a concert and mention the backer in the programme, it’s a symbolic reward, and not liable for VAT.
Things to consider before starting a crowdfunding campaign
Now you’re more clued up on where crowdfunded cash stands in terms of tax and VAT, you might be feeling more inspired to kickstart your campaign. Before you do though, here are some things you should consider first.
Have you got the time and resources to market it?
Crowdfunding campaigns are only a success when it reaches people en-masse, and this requires significant investment of time and energy into marketing and promotion. So, before setting up a campaign, it’s essential that you have the resources available to support this.
Is your Intellectual Property (IP) safe?
The whole concept of a crowdfunding campaign is that your business idea reaches as many people as possible and drums up as much financial backing as a result. Consequently, your product or service is going to be exposed to large numbers of people – quite possibly including your competitors.
That’s why it’s so critical to make sure your Intellectual Property (IP) is well protected before you share your hard work with the world.
Is it really the most viable financial option for you?
Crowdfunded money is classed as business income by HMRC. This means that any money you make will contribute towards your VAT taxable turnover and VAT bill. If you’re not yet VAT-registered, the crowdfunded money will take you closer to the threshold (£85,000 in a rolling 12-month period) that will require you to register for VAT.
Crowdfunded income also has the potential to push you into a higher tax band if you’re a sole trader, or will be subject to Corporation Tax if you’re a limited company. On the other hand, you can often offset the costs of the campaign as an allowable expense.
If you’re struggling to decide which route to go down to seek funding for your business, then speak to an accountant. They’ll be able to help you weigh up the pros and cons of your options from a neutral perspective, with the best interests of your business growth and financial health in mind.
Good luck with your crowdfund!