Crowdfunding Gets Major Boost From New Startup Payroll Tax R&D Tax Credits



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Crowdfunding-Major-Boost
        Access to capital markets is becoming increasingly practical for start-ups nationwide.  Crowdfunding is an innovative way to raise funds from a diverse range of investors of any size.

        Over the past few years, platforms like Kickstarter Inc. in NYC and Indiegogo, Inc. in San Francisco have significantly reduced barriers to funding for small entrepreneurs.  Traditionally, small inventors and product creators struggled to bring their innovations to market because they had no exposure to capital markets.   

        More recently, online funding platforms have emerged that allow small entrepreneurs to market their products to investors on a micro-level.  In 2008, the number of crowdfunding platforms worldwide increased by 38% in comparison to the previous year.  That growth rate continued to climb year-over–year until it peaked in 2012 at 60%.  Since that time, total funding volume has reached over $34 billion.

        Other recent developments are equally encouraging for both start-ups and investors.  Startups that develop products and improve processes are good candidates for the Research and Development (R&D) Tax Credit which was recently amended by Congress in a favorable way for taxpayers.  


The R&D Tax Credit

        Enacted in 1981, the Federal Research and Development (R&D) Tax Credit allows a credit of up to 13 percent of eligible spending for new and improved products and processes. Qualified research must meet the following four criteria:

  • New or improved products, processes, or software
  • Technological in nature
  • Elimination of uncertainty
  • Process of experimentation

        Eligible costs include employee wages, cost of supplies, cost of testing, contract research expenses, and costs associated with developing a patent.  On December 18, 2015, President Obama signed the bill making the R&D Tax Credit permanent.  Beginning in 2016, the R&D credit can be used to offset Alternative Minimum tax and startup businesses can utilize the credit against payroll taxes


R&D Tax Credit For Startups

        The new federal tax law is extremely beneficial for startups.  For the first time ever, a qualifying startup can use the credit against $250,000 per year in payroll taxes beginning January 1, 2016.  Essentially, with the new startup provision, companies can claim the credit even if they do not pay income tax and regardless of their profitability.   The chart below demonstrates the dollar value of the tax credit for a startup that employs an engineers and technical people.

Chief Engineer Salary

$200,000

2 Plant Managers

$300,000

15 Engineers/Technicians

$1,500,000

Prototype and Software Consultants

$1,570,000

Total Qualified Research Expenses:

$3,570,000

 

 

Total R&D Credit Value (1 Year)

$250,000

Total R&D Credit Value (5 Years)

$1,250,000



Industry

        The crowdfunding industry is expanding rapidly.  In 2010, global crowdfunding platforms processed $880 million in contributed capital.  In 2012, $2.8 billion was transferred across crowdfunding platforms.  By 2014, that number had swelled to $16 billion.  For 2015, contributed funds are expected to exceed $34 billion.  The World Bank recently estimated that crowdfunding would reach $90 billion by 2020.  However, if the trend of doubling year over year continues, crowdfunding could reach $90 billion even sooner, by 2017.

        The largest global crowdfunding market is by far North America.  In 2014, North America led the world in crowdfunding volumes, growing by 145% and raising a total of $9.46 billion.  Asia was a distant second at $3.4 billion and Europe came in third at $3.26 billion.   As of this writing, the United States has at least 191 crowdfunding platforms.  The United Kingdom is in second with 44.  The chart below demonstrates the global crowdfunding increase since 2012.





Crowdfunding Sites


Kickstarter Inc., in New York, is one of the most well recognized crowdfunding sites on the market.  As of this publication, over 10 million people, from every continent on earth, have backed a Kickstarter project of one type or another. Creators use the platform to find the resources and support they need to makes their ideas a reality.  Those ideas include everything from filmmaking, design concepts across varying industries, and innovative technology solutions. Furthermore, New York itself is becoming an increasingly tech oriented economy.  Tech companies are drawn to this region because it offers easy access to funding, local university research labs, and an increasingly broad based tech-oriented community. 
 

Indiegogo, Inc.  is an international crowdfunding website founded in 2008 and headquartered in San Francisco.  Generally, the site allows people to solicit funds for almost anything from tech, to film to small businesses, and musical entrepreneurship.  The company brands itself as the largest global site for fundraisers.  Their market includes anyone who has an idea and wants to raise funds to finance their goal.  Currently, fifteen million unique users from around the world visit their site on a daily basis.  

 -- Crowdsource funding candidates should consider disclosing how much of the $250,000 per year in R&D Tax Credits they intend to generate. --



Crowdfunder, Inc. in Los Angeles is a platform for raising investments.  It has one of the largest and fastest growing networks of investors.  Recently featured on Fox News, one company who utilized Crowdfunder, Oculus VR, LLC, which develops virtual reality products, recently, raised $2 billion from Facebook after debuting on the Crowdfunder website.  Crowdfunder offers equity crowdfunding from individuals, angels, and venture capitalists, and was also a leading participant in the JOBS Act which provides supporting legislation for crowdfunding operations.


Appbackr, Inc., in Palo Alto, California is a crowdfunding platform for comparing, identifying and exploring mobile apps.  Their market is based almost entirely in this niche community.   Their mission is to index the world’s apps, enabling app users to make informed and inspired decisions, and making apps accessible to everyone through the App Anatomy™ Project.


AngelList, in San Francisco, brands themselves as an organization that makes fundraising efficient.  As of this publication, they raised at least $400 million for at least 765 startups that are listed on their website.  When they first debuted, they did not brand themselves as a crowdfunding platform because initially they catered to venture capitalists.  More recently, however, they have begun expanding their scope, funding a growing number of top tech startup deals in a variety of ways.  


Prototypes

        Many entrepreneurs use crowdfunding sites to market newly developed products to investors.  Central to most startup marketing strategies is a focus on prototype development.  Most startups that develop products display their prototypes on crowdsourcing sites.  Investors are generally more willing to invest in products when they can actually see the product, or the prototype.  Some startups even make public their design specifications.  

        Van Den Nieuwenhuizen, from Sydney, Australia, is a technology consultant for many Fortune 500 companies who designed a portable Bluetooth speaker and had this to say about his prototype:  

“Once my partner and I had a design we liked, we submitted it to some design blogs. The response was very positive, with people asking how they could buy it, and all we had at that point was a rendering. We made our first prototype with a trip to the hardware store. It took us a year of looking in the U.S. and Asia to find the right manufacturer. Even if you don’t have a prototype yet, you can release drawings or renderings on Facebook and Twitter. You get validation of your idea while building an audience and momentum for your crowdfunding launch.”   

        The media likes prototypes, too.  Many startups on crowdsourcing platforms report that the best way to generate publications is to send a prototype to the analysts and writers.  The vast majority of these professionals will not write anything about the product if they cannot observe it in real life.  Kickstarter even offers advice for proper prototype treatment including the following:

  • When it comes to projects that manufacture and distribute hardware, gadgets, and other products, it’s important to make sure backers know what stage of development the project is in.
  • Do show backers a prototype.
  • Provide backers with a realistic sense of where the project stands — including what’s been accomplished so far, and what work remains to be done.
  • If your project will involve manufacturing gadgets or other products, we ask that you show as much as you can about how you're going to do that, including things like a production plan, an estimated schedule, and any other details you can provide for backers.
  • Projects that involve the development of physical products must feature explicit demos of working prototypes. While you can run a project focused on the creation of a prototype, you can't offer the product that is under development as a reward.

        Prototypes are a bit different from sketches and generally represent the product at a more advanced stage of development.  Of course, the investment in the prototype is larger than the investment in the sketch; however the prototypes also create more value.  Investors that can explore tangible products with all their senses are more likely to invest in them.  Rather than imagining a design concept or simply observing a drawing, they can actually see that the product works as intended and that the entrepreneur has invested the time and money to actually develop the product.


3D Printed Prototypes

3D printed prototypes are a revolutionary development for inventors and product creators.  With 3D printers, it is now possible to develop complex products from the concept stage to a working prototype in a very short time period.   Many prototypes have tiny, complex mechanics that would otherwise be difficult to construct using small hand tools.  3D printing saves time and money because prototypes do not have to be assembled, which can often be a tedious process.  Instead, the 3D printer makes it so that the product functions as one completely whole and complex design.  


Conclusion

    Crowdfunding is becoming an increasingly practical way of raising money for startups across all industries, particularly tech-oriented businesses.  New federal Research and Development Tax Credit legislation provides a boost to startups that can now use the credit to offset up to $250,000 per year in payroll taxes effective January 1, 2016.  

Article Citation List

   


Authors

Charles R Goulding Attorney/CPA, is the President of R&D Tax Savers.

Andrea Albanese is a Project Manager with R&D Tax Savers.

Michael Wilshere is a Tax Analyst with R&D Tax Savers.