Kickstarter · Startups

Is a Kickstarter instant debt?

Megan May UI Designer at Chicyy

January 2nd, 2016

Recently read an article called Kickstarter is Debt, and was curious how others felt about it. Are Kickstarter's a good idea for all startups? Why or why not and how do you ensure that it does not give you debt? Curious to hear others opinions on this- 
More than 65% of new companies fail because they lack funding. In this course, you’ll learn common fundraising mistakes, how to nail an elevator pitch, how to craft a killer pitch deck, where to source investments from, and all about term sheets and convertible notes.

Charles Dreher Executive Director & Vice-Chairman - Investment Policy Committee

January 2nd, 2016

Hello Ms. May,

Excellent question.

Here is an excerpt taken from the e-book our CEO wrote entitled, "The Secrets of Wall Street - Raising Capital for Start-Up and Early Stage Companies"

Chapter 3 The Perfect Storm

"Donation-fueled crowd funding really isn’t considered raising capital-certainly not substantial amounts-because that model is weak and fading fast. In addition, do you realize crowd-funded proceeds are considered revenue and therefore subject to federal and state income tax?1 2 That’s right… If you were even remotely lucky enough to raise $500,000 through a crowd-funding model for your “C” corporation, under the tax code for 2015 and assuming a flat 6% state-tax corporate rate with little or no cost of goods sold (the cost of the little thank-you gifts), you can expect to pay 58% or $290,500 to the government. You’d be left with only $209,500 in working capital-hardly worth it. Even LLCs are subject to this extreme, tax treatment. Due to the pass through of average, individual, tax brackets and factoring in FICA & Medicare withholdings (aka selfemployment tax) make the effective tax-rate percentage essentially the same.  It is our understanding that some of the crowdfunding portals do send out 1099-MISC tax reporting forms to recipients of funds from a donation fueled crowdfunding campaign. They do so to shift that liability of their backs and onto yours."

If you would like to read more download your complimentary copy of the abridged edition here:  https://www.commonwealthcapital.com/Financial_Architect/?atid=4750  

John Currie ITERATE Ventures - Accelerating Science & Technology Ventures www.iterateventures.com

January 2nd, 2016

Megan, thanks for the question and the url to the article. Ben does a great job giving a finance lesson on debt financing sources .... article is a real keeper!  great perspective on all the grey shades of debt options.

I don't look at Crowdfunding that way.  For YOUR venture, what is a compelling OFFER you can make that people will jump on?  You have to do a lot of homework to come up with a compelling financial offer - to meet everyone's goals.

I firmly believe that Crowdfunding is nothing more than SUPERIOR marketing. Crowdfunding forces the entrepreneur to think through their targets, the pain points, how to message directly to the targets, and close on a compelling call to action where they GE something.  You control the offer.

Jason Cooper Executive Producer at King Toledo Entertainment

January 3rd, 2016

It's only 'debt' in that you owe something to your backers - it isn't really an instrument of debt. If you want to think of it that way, sure, that's totally fine. Your only real obligation to that debt is to make a good faith effort to create the thing you've promised. That said, there is something more at the heart of this article worth discussing. The risk of defaulting on this 'crowdfunding debt' is MUCH worse (IMO) than if you weren't able to pay back a traditional debt instrument. 

Why? Well, if you don't make good on your crowdfunding proposal, your social capital takes a major hit publicly. That's the hidden element of crowdfunding that many people miss. Financial troubles can usually be managed and worked out behind the scenes - your social capital is much harder to rebuild. It's your reputation that goes on the line when you solicit backers from the crowd. Should you underperform or fail to communicate in the event you cannot deliver, you will lose all credibility with your highest value customers. These are people who believed in you so much that they backed you before the product or service you are offering even really existed. To let them down would be a major roadblock in doing anything with them in the future. On the other side, if you can meet or exceed their expectations, not only will you have their capital up front, but a lifetime of support (marketing, outreach, word-of-mouth, repeat business, backers for your next campaign, etc).

Anonymous

January 3rd, 2016

No, "kickstarter" is not debt. It is simply a hand shake with each and every contributor to "make good" on a promise. Yes, some call that a debt. I have a strong distaste for negative connotations. Plus, promises don't go on a balance sheet or income statement. 

And no, crowdfunding is not right for every business. Rewards based crowdfunding is a great pre-revenue sales and marketing tool.

Chris Kitze CEO at Safe Cash Payment Technologies, Inc.

January 3rd, 2016

It's not a debt in the sense that there is no security interest in your company and that the money paid has to be returned with interest.  However, when a customer pays you something, they have a claim on your resources.  If you think about it, every customer has this.  Gain and loss.  Getting more customers is a good thing, let's not forget that.

Michael Meinberg Teacher (iOS Development) at The Mobile Makers Academy (A Hack Reactor School)

January 5th, 2016

It is a kind of a debt.  But really it is 'pre-orders'.  Of course you have to fulfill the orders, but you also already have the capital.    Done right, however, it is an excellent way to validate your idea without spending a tone of capital up front. 

Elliott Dahan

January 3rd, 2016

It is a debt in that you have an obligation to folks who pledged money to you. You have a debt in that you should actually build what you presented and you should thank these folks for believing in what you did.

George Parrish Founder/President

January 3rd, 2016

If you can't sell, or don't know how to sell anything......and I mean anything....it won't matter if yours or anyone else's StartUp raises funds via KickStarter or any future Equity Crowdfunding platform, Angel or V/C.  You've got to spend money to make money (depends on your circumstances as to how much or how little you spend), and you can't worry about debt.  You had better worry about selling your idea, solution, MVP or doo-dad to make it in the market.  Or be born with a silver spoon in your mouth. 


Anonymous

January 3rd, 2016

Neil, from a legal (GAAP) vantage point you are correct. If and ONLY if you are using an accrual basis for tax purposes.

Let me be 100% clear: startups MUST use cash basis accounting if they ever expect to make it in the real world.

At least in the USA. By the way, see any of a thousand sources on NEVER using "financial accounting" in place of "managerial accounting". Yes, at some point your startup will need real financial help. But rarely [okay, NEVER] when launching a kickstarter campaign.

If [and this is a BIG if, as the percentage of kickstarters that succeed is around 36%] you are successful, then the cash goes on the books. And yes there is NOW a contract. And a debt.

However, I didn't read into the question, "should I hire a CPA" before launching a kickstarter campaign.

If you await all green lights before leaving the house, you will never leave the house.

P.S. Sorry, but this thread struck a nerve for me. Everyone means well, of that I am sure. But after 30+ years in the startup world, buying, creating and occasionally selling small businesses [and once in a while managing inside them], I get tired of people seeking balance before they achieve anything measurable. My only goal here is to simply say please don't let the fear of accounting keep you from launching a kickstarter project. I have seen it happen too often. Trial and error is still a valid business tool.

Karl Guttag CEO at iTreatR Inc.

January 2nd, 2016

Presales definitely have associated with them an obligation/form of debt. There are good reasons to do presales campaigns such as (perJohn Currie) a form of marketing and a way to show traction to investors as well as getting feedback.


If you are delivering even a moderately complex device (as opposed to say simple already written software or something very simple to make) then after you have to subtract the material, manufacturing(including tooling), labor, shipping, returns, and marketing cost from the proceeds, you will likely be left in the hole.


As the Bolt article points out, it is revenue but with a debt associated with it. The presale will often only be defraying a part of the eventual costs for which you will be taking on as an obligation to delivering the product. And as the Bolt article points out, you should only be using the presale money for things directly associated with the product build (not design and overhead for example).


Thus it looks a debt and you might not even know how much you debt you have taken on if you are waiting to build the product based on pre-sales, like many beginner companies. It likely will take follow-on sales to actually turn a net profit.


Worse yet, some pre-sales campaigns have "stretch goals" that obligate them to add more features which can dig the hole even deeper (the more goals they hit the more they are obligated to lose).


Probably a good summary of the Bolt article is, "if you think that presales are capital, then you are going to be in trouble".