Kickstarting Federal and State R&D Tax Credits



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        It is estimated that Kickstarter and other crowdfunding platforms raised $5.1 billion in 2013, almost double the $2.7 billion raised in 2012. The consensus is that this funding mechanism, still in its infancy, is poised for exponential growth. Many of these investments are for new products and product designs that are eligible for federal and state R&D tax credits. By combining the cash from investors and the cash saved from R&D tax credits, business owners greatly improve their chances of success.



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 January 2, 2013, President Obama signed the bill extending the R&D Tax Credit for 2012 and 2013 tax years.



Crowdfunding Models: There are two types of crowdfunding models:

Donation Model:

        This model, used by Kickstarter, Indiegogo, and others, uses cash donations typically in exchange for early access to the product. To date, this is the most popular funding model.

        Kickstarter

Kickstarter is an independent company headquartered in Greenpoint, Brooklyn. Kickstarter was founded in 2009 and as of year end 2013:

  • 5.5 million people have provided
  • $958 million
  • for 55,000 creative projects

The year 2013 set funding records with 18,000 successful products. Kickstarter is a platform and resource; and is not involved in the development of the projects themselves.

Anyone can launch a project on Kickstarter as long as it meets the prescribed guidelines. Some Kickstarter projects are submitted by established industrial design firms3 where eligibility for R&D tax credits is probable. New 3D printing technologies are increasingly utilized for industrialized design projects.

Kickstarter campaigns can serve to identify major new technology offerings. The 'Dark Sky' weather application was launched after raising $40,000 on Kickstarter. The app has been downloaded over 400,000 times. Fortune magazine attributed Monsanto's $1 billion purchase of Climate Corp. in part to the Dark Sky model.

Various Kickstarter funds are for films and other fine arts projects and are less likely to qualify for research and development tax credits. Kickstarter retains 5% of project funding. The guidelines require that minimum funding levels be achieved within a prescribed time frame or the money is returned.

Some Kickstarter companies have raised substantial funds. For example, in 2010 TikTok/LunaTik wristbands, a wearables company, raised almost $1 million.

Indiegogo, headquartered in San Francisco, is an international crowdfunding site founded by Danae Ringelmann, Slava Rubin, and Eric Schell in 2008.

Equity Based Model:

        With this model, the cash provider becomes an equity investor. The two first major companies in this area are Upstart and Pave.

        Upstart, headquartered in Palo Alto, CA, allows promising college graduates and entrepreneurs to upload pictures and information about themselves, including their resume, academic performance, credit score, and fun facts. This "Upstart" profile is similar to a Kickstarter campaign in that it aborts the investment if the full amount is not pledged within a certain timeframe.

        Upstart estimates that backers will earn an 8% return if the recipient meets or exceeds expectations, making the terms for a recipient comparable to a loan at 8% interest.

        Pave, headquartered in New York City, is a similar endeavor that launched in New York in December 2013 Pave focuses a bit more on creative entrepreneurs, whom it calls "prospects" and funded eight people in its pilot launch.



The New Startup Environment

        The overall environment for startups is better than it has ever been since resources like Amazon Cloud Drive provided low cost platforms that enable any start up to have the same technology resources as larger companies. Lean Startup methodologies enable new businesses to launch much faster and with less capital than prior generation startups. Some states, including New York, have their own startup tax incentives. Financing costs remain at all time lows and experienced business operators, in particular, can augment new crowdfunding with low cost debt financing.



JOBS Act Federal Regulatory Requirements

        The federal Jumpstart Our Business Startups (JOBS) Act provides a new securities law exemption for internet based crowdfunding investments. However, there are suitability/underwriting standards that are designed to protect the investing public. The SEC proposed rules are as follows:

  • A company would be able to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12 month period.
  • Investors, over the course of a 12 month period, would be permitted to invest up to $2,000 or 5% of their annual income/ net worth, whichever is greater, if both their annual income and net worth are less than $100,000.
  • During the 12 month period, these investors would not be able to purchase more than $100,000 of securities through crowdfunding.

        The SEC proposed rules also state that:

        Certain companies would not be eligible to use the crowdfunding exemption. Ineligible companies include non-U.S. companies, companies that already are SEC reporting companies, certain investment companies, companies that are disqualified under the proposed disqualification rules, companies that have failed to comply with the annual reporting requirements in the proposed rules, and companies that have no specific business plan or have indicated their business plan is to engage in a merger or acquisition with unidentified companies.

        As mandated by Title III of the JOBS Act, securities purchased in a crowdfunding transaction could not be resold for a period of one year. Holders of these securities would not count toward the threshold that requires a company to register with the SEC under Section 12(g) of the Exchange Act.



Disclosure Requirements

        Title III of the JOBS Act crowdfunding securities exemption also requires certain disclosures. SEC proposes the following:

  • Filing certain information with the SEC, and providing it to investors (including potential investors) and the relevant intermediary facilitating the crowdfunding offering.
  • Information about officers and directors as well as owners of 20% or more of the company.
  • A description of the company's business and the use of proceeds from the offering.
  • The price to the public of the securities being offered, the target offering amount, the deadline to reach the target offering amount, and whether the company will accept investments in excess of the target offering amount.
  • Certain related-party transactions.
  • A description of the financial condition of the company.

        In addition to the proposed documentation above, the SEC would also require:

        Financial statements of the company that, depending on the amount offered and sold during a 12 month period, would have to be accompanied by a copy of the company's tax returns or reviewed or audited by an independent public accountant or auditor.

        Companies would be required to amend the offering document to reflect material changes and provide updates on the company's progress toward reaching the target offering amount.

        Companies relying on the crowdfunding exemption to offer and sell securities would be required to file an annual report with the SEC and provide it to investors.



Conclusion

        These are exciting times for startups. New funding vehicles and support systems are enabling new ideas to become viable businesses faster than ever before. Federal and state research and development tax credits can be utilized to further enhance these opportunities.

Article Citation List

   


Authors

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

Jacob Goldman is the VP of Operations at R&D Tax Savers.

Eliana Goolcharan is a Tax Analyst with R&D Tax Savers.


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