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Guide to Donation-Based Crowdfunding

Guide to Donation-Based Crowdfunding
Lauren Ward
Lauren WardUpdated November 21, 2022
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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
Donation crowdfunding is when large numbers of people give a person, company, or campaign money through a crowdfunding platform. What makes it stand out from other types of crowdfunding is that the donors generally do not receive anything in return for making a contribution.While donation-based crowdfunding is typically more geared toward charities and nonprofits, it can also be a way for a business, even a startup, to raise funds.Read on to learn more about donation crowdfunding, including how it works, and how it might help your company raise capital.

What Is Donation Crowdfunding?

Donation-based crowdfunding is defined as a way to raise money for a project by asking a large number of contributors to individually donate a small amount. Like other types of small business crowdfunding, the money is donated via a fundraising platform, such as Kickstarter or Indiegogo. Unlike other types of crowdfunding, contributors are generally not offered a product or an ownership stake (equity) in a company for their donation, nor do they need to be paid back. Donors typically give to help out a project they feel particularly passionate about.Some definitions of donation crowdfunding, however, include “rewards” crowdfunding. Using this broader definition, donors may receive token rewards that increase in prestige as the size of the donation increases. For small contributions, however, the funder may not receive anything at all.

How Does Donation Crowdfunding Work?

For entrepreneurs, donation crowdfunding can be a viable alternative to traditional means of raising money, such as applying for a small business loan or bringing on investors. To start a donation crowdfunding campaign, you typically need to create a page on one of the top crowdfunding sites. You may also want to make a video explaining why you need the money and what you plan to do with it to bring your campaign to life.In addition, you’ll need to set a fundraising goal, which is the minimum amount you need for your project. It’s important to set it high enough, but not too high. If your goal is not met, crowdfunding sites typically send all contributions back to the donors. Donation-based crowdfunding platforms for businesses include Kickstarter, Indiegogo, CrowdFunder, and RocketHub. 

Pros and Cons of Donation-Based Crowdfunding

Pros of Donation-Based CrowdfundingCons of Donation-Based Crowdfunding
Increased brand awarenessCan take a lot of time and effort to create a successful campaign
Option to test the market prior to launchCan be costly, especially if you create a video
No loss of equityOversaturated market
A successful campaign could help you qualify for other types of funding in the futurePotential for no gain
Donation-based crowdfunding may seem too good to be true — free capital for your company with zero strings attached. The reality, however, is that it can take a lot of time and effort (and, in some cases, money) to launch a successful crowdfunding campaign. Here’s a closer look at the pros and cons of donation crowdfunding.

Pros

In addition to offering free money, donation crowdfunding allows you to raise awareness and excitement for your business or project. As a result, it can double as a powerful marketing tool. What’s more, it gives you a chance to test out your product or service and see how people are responding to it. Another plus is that you don’t have to give up any ownership of your business to raise capital. And, unlike various types of business loans, you don’t have to pay the money back plus interest. Finally, should you need more capital in the future, having a successful crowdfunding campaign under your belt could help convince a lender or investor that your firm is a solid bet with a product or service that has public appeal.

Cons

On the downside, crowdfunding has become a fairly “crowded” space in recent years. As a result, it can take a great deal of time and effort to create an attention-getting and successful crowdfunding campaign. There may also be costs involved in launching your campaign, especially if you choose to make a high-quality, high-impact video, with no guarantee of any returns. If you don't meet your goal, the site will generally give donors their money back.Even if your campaign is successful, you typically don’t receive 100% of each crowdfunding donation. Crowdfunding platforms generally keep 5% to 10% of all donations as a service fee.

Donation Crowdfunding for Startups

Startups often face hurdles when it comes to getting small business loans and may lack the connections to find financial backers. With crowdfunding, however, entrepreneurs can reach out to a large number of potential investors all at once. To succeed with a purely donation-based campaign, however, you typically need to have a mission-based focus or a project that addresses a pressing issue, such as climate change, to gain support. If that’s not the case, you may have more success with a rewards, equity, or debt crowdfunding campaign (more on those below). 

Tax Implications of Donation-Based Crowdfunding

Generally, if an individual raises money through crowdfunding without giving something in return, it is considered a gift and is non-taxable. If the donors were given rewards for their donations, on the other hand, those donations are typically considered taxable income.The rules are somewhat different in the case of a business, however. If the goal of your donation-based crowdfunding is to raise money for a project that would clearly be considered a trade or business, then it will likely be considered taxable business income, even if you don’t offer anything in return for those contributions.You may not have to pay taxes on all of that income, though. The funds that your business spends on a project might be considered deductible business expenses. If these expenses reduce your taxable income by the same amount as the donations, you could potentially not end up paying income tax on the donations, even if they are technically taxable.Tax law and crowdfunding are complicated, however, so you'll want to consult a CPA or other tax professional to understand how any money raised through donation crowdfunding will be treated. In addition, the IRS instructs business owners to keep thorough recordkeeping for all money received through crowdfunding for at least three years after the campaign.

Other Types of Crowdfunding

Donation-based crowdfunding is one of several different types of crowdfunding. Here’s a look at some of the other popular models.

Equity crowdfunding 

With equity crowdfunding, a small business or startup gives away a portion of its business in exchange for funding. The donations are considered a type of investment, where participants receive shares in the business based on how much money they contribute.

Reward Crowdfunding 

With this model (sometimes considered a subset of donation crowdfunding), donors receive a token of appreciation in return for their pledges. The rewards might vary depending on the size of the donation in order to incentivize higher contributions. Donors might receive a T-shirt or the product or service being funded for free or at a discounted rate.

Debt Crowdfunding 

Also known as peer-to-peer (P2P) lending or crowdlending, the money donated by contributors with this model is a loan and must be repaid with interest by a certain deadline.

Other Ways to Fund Your Business

If you don’t think crowdfunding is the right funding avenue for your business, here are some other options you may want to consider.

Small Business Loans

A small business term loan provides a lump sum of capital upfront that you repay in monthly installments (plus interest) over the length of the loan, known as the term. Banks often require at least two years in business to qualify for a loan. However, some online lenders offer business loans for startups with under a year in operation. Depending on the lender, you may be able to access different types of business loans, such as short-term loans, startup business lines of credit, invoice factoring, or equipment financing.The U.S. Small Business Administration's microloan program is also startup-friendly, offering loans of up to $50,000 for small businesses looking to start or expand. Recommended: Small Business Loans for Startups

Grants for Small Businesses

Much like donation-based crowdfunding, a business grant is money that does not have to be paid back. There are different types of small business grants available from private foundations and government agencies. Because they aren’t loans, however, competition for grants can be stiff. If you meet a particular grant's requirements, however, the chance for free capital might be worth the hard work. Grants.gov can be a good place to start your search. 

Angel Investors

Angel investors are typically high-net-worth individuals who invest in small businesses  in exchange for ownership equity in the business. Besides funding, these investors also often offer operational expertise and valuable business connections. You may find an angel investor among your family, friends, or professional circle. Joining a business incubator or accelerator is another way to gain mentorship and meet potential angel investors.

Check Your Small Business Loan Rate 

Donation-based crowdfunding is one of many avenues for getting funds for your small business. If you’re interested in exploring others, Lantern by SoFi can help. With our online loan comparison platform, you can access multiple small business financing options matched to your company’s needs and qualifications.Let Lantern connect you with the right lender for your small business.
Photo credit: iStock/Sanja Radin
This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice. Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.LCSB0922005

Frequently Asked Questions

What exactly is donation crowdfunding?
How are donations and crowdfunding any different?
Are donations for crowdfunding tax deductible?

About the Author

Lauren Ward

Lauren Ward

Lauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.
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