As was evident after the horrific shooting in Orlando on June 12th, crowdfunding has become the most visible, and arguably the most effective, way to quickly raise money and awareness for a charitable cause triggered by an event. The Nonprofit Quarterly previously reported that a single crowdfunding campaign to support the Orlando victims raised $4 million from more than 87,000 people within a day after the attack. And five days later, reportedly, more than 300 crowdfunding campaigns raising $6.2 million for victims of the shooting were set up on GoFundMe, which is just one of more than 2,000 crowdfunding websites.
However, while the magnitude and reach of crowdfunding are substantial, there remain many misperceptions and issues to be understood and managed by nonprofits, donors, and regulators.
What is Crowdfunding?
Crowdfunding is a term used to define an effort to generate capital investments or funds for a project, cause, or enterprise by acquiring funds from many individuals. This is typically accomplished by raising small amounts of money from a relatively large number of people (the “crowd”) on the Internet.
The global crowdfunding industry expanded by 167% to reach $16.2 billion in 2014, up from $6.1 billion in 2013. The industry reached $34.4 billion in 2015. In another study commissioned by the World Bank in 2013, crowdfunding is projected to become a $90–96 billion dollar industry by 2025, almost twice the size of the global venture capital industry today.
Types of Crowdfunding
Crowdfunding can be categorized into three broad types: donation crowdfunding, rewards crowdfunding, and investment crowdfunding.
Donation crowdfunding involves asking the crowd for a gift.
Rewards crowdfunding involves the promise of some return benefit to the crowd. If the return benefit is of negligible value, this is a form of donation crowdfunding. If the return benefit is considered a form of pre-selling by a startup for-profit, it may be a form of investment crowdfunding.
Investment crowdfunding involves the selling of equity (e.g., stock) or debt (e.g., note promising a rate of interest).
For charitable causes, popular crowdfunding platforms include GoFundMe, CrowdRise, and Indiegogo/Generosity. To host a campaign, these platforms charge fees that range from 0% to 5%, in addition to third-party payment processing fees that can be an extra 3 or 4% plus $0.20 or $0.30 per donation, or more for international campaigns with non-USD bank accounts.
Crowdfunding for Charitable Purposes
Nonprofits that use crowdfunding most commonly do so as a form of fundraising. Often, they will provide a reward to help induce a donation, but the value of the reward will not exceed the amount of the donation. This will help ensure that at least part of the donor’s payment will be eligible for a charitable contribution deduction. While nonprofits may also be able to engage in investment crowdfunding, they generally have no ownership structure (and therefore no equity), and so such efforts are limited to debt crowdfunding. In contrast, a nonprofit’s for-profit subsidiary or joint venture may be able to engage in equity crowdfunding.
Donation crowdfunding typically is project-focused and time-limited and targets a broader group of prospective donors who are more interested in the project or cause than a particular organization.
Also growing more prevalent are personal crowdfunding campaigns, in which an individual, friend, family, known supporter, or unrelated person sets up a campaign to benefit a specific person for their medical expenses, education costs, or other reasons. Exceptional campaigns like this that made the headlines include the effort to buy a car for a 56-year-old Michigan man who walked 21 miles each day to and from his factory job, and campaign for a vacation for the bus monitor who was bullied and verbally harassed each day by a group of middle-schoolers in New York. The latter raised over $700,000 by more than 30,000 backers. Nonprofits are cautioned against trying to divine the formula for what makes a campaign go viral and instead plan realistically.
Crowdfunding by Nonprofits
Nonprofits soliciting charitable contributions must comply with applicable state laws, including any charitable registration requirements, in each of the states in which they are making such solicitations. Currently, 39 states and the District of Columbia require registration and several of the remaining states may require a certificate of authority.
Because online solicitations inherently do not operate within state boundaries, there has been great confusion regarding state registration requirements. In recognition of this complexity, in 2001, the National Association of State Charity Officials (NASCO) approved the Charleston Principles. This provides nonbinding advisory guidance that a nonprofit would be required to register for online charitable solicitations if the nonprofit solicits donations through an interactive website; and the nonprofit either: (i) specifically targets persons located in the subject state for solicitation; or (ii) receives contributions from the state on a repeated and ongoing basis or a substantial basis through its website. Thus, it may be difficult to determine whether a nonprofit’s crowdfunding campaign is triggering multi-state registration requirements.
Nonprofits must also be aware of issues involved in using a professional or commercial fundraiser, a regulated business in many states. Generally, a professional or commercial fundraiser is paid to either solicit or control charitable contributions for a charity. In the states where such fundraisers are required to register, nonprofits may be required to enter into contracts only with those professional or commercial fundraisers who have properly done so. Further, nonprofits must generally establish and exercise control over fundraising activities conducted for their benefit. This obligation includes approving all written contracts and agreements, and assuring fundraising activities are conducted without fraud or coercion.
While it’s likely that the vast majority of companies that operate crowdfunding sites receive compensation for hosting campaigns, many avoid categorization as a professional or commercial fundraiser by refraining from soliciting funds themselves. Instead, they act as providers of the crowdfunding platform and leave the content of the solicitation up to the individual campaign creators. In addition, these crowdfunding operators may not receive or control the solicited funds. The funds raised are relayed by payment processors, like WePay or PayPal, into accounts controlled by the soliciting party.
Nonprofits that plan to engage in crowdfunding must also be careful not to act as a conduit for a particular person or taxable or foreign entity. By creating a campaign to specifically benefit one person or foreign entity will defeat a donor’s ability to take a charitable contribution deduction and jeopardize the nonprofit if it misrepresents that the donor can take a deduction. Where the nonprofit acts as a conduit, the donor has in substance made a nondeductible contribution to a nonqualified recipient. In contrast, a nonprofit may feature an example of one of its beneficiaries without promising or implying that all contributions will be directed to such individual or entity. It also may promise in its campaign to use a gift for a particular purpose, in which case, the gift will be considered restricted to such purpose.
Both nonprofits and donors should be aware of the IRS rules regarding substantiation of a donation. To receive a charitable contribution deduction, a donor must maintain a bank record or a written communication from the charity showing the name of the organization, the date of the contribution, and the amount of the contribution. For contributions of $250 or more, the donor must receive a written acknowledgment from the nonprofit containing certain required language. Where the nonprofit provides a return benefit for a contribution that exceeds $75, the law generally requires the nonprofit to provide to the donor a written disclosure of such quid pro quo contribution, indicating the amount that can be deducted. No disclosure is required when the good or service given by the charity in return for the donation is of insubstantial value.
If a reward crowdfunding campaign is soliciting quid pro quo contributions, the part of the transaction that is considered a sale rather than a charitable contribution may trigger for the nonprofit state requirements for a seller’s permit and remittance of sales tax. Moreover, if such sale is not directly in furtherance of the nonprofit’s exempt purpose, the sale may also have unrelated business income tax (UBIT) consequences for the nonprofit.
Crowdfunding By Others
Because 501(c)(3) organizations must be organized and operated to benefit a charitable class instead of a particular individual or small group of individuals, personal crowdfunding run by individuals has been a popular alternative to nonprofit crowdfunding. Personal crowdfunding can be very effective in providing immediate and direct assistance to a person or specific family or entity in need after an event. However, as opposed to campaigns run by charities that are heavily regulated to protect donors from fraud and ensure transparency, individual-run campaigns can be created for any lawful purpose, including for purely selfish reasons, and the resulting funds may be used without public disclosure.
One often misunderstood, and sometimes misrepresented, point is that donors do not benefit from a charitable contribution deduction when donating to an individual, even if for a charitable purpose.
Moreover, donors to individual campaigns may never be able to check whether their donations were used for their intended purpose the way they may if their donations had gone to a charity with public reporting requirements. Crowdfunding operators, like Crowdrise, typically do not verify the authenticity of the solicitation and, unlike charities, they do not oversee the use of funds raised. Accordingly, it can be easy to fraudulently raise funds for what appears to be a charitable purpose with no external oversight.
In response, some crowdfunding operators have created vetting and verification procedures to signal to donors that a qualified charity is running and/or overseeing a particular charitable campaign. Indiegogo/Generosity, for example, has a Trust and Safety team that verifies the legitimacy of campaigns, as well as a propriety fraud algorithm that reportedly alerts the company to any suspicious activity. However, what remains unclear is whether nonprofits can and will stop unauthorized personal crowdfunding campaigns explicitly operating for, or purportedly for, the nonprofit’s benefit.
While personal crowdfunding can be effective when the campaign clearly states who its creator is (and whether it is attached to a charity that is supervising the campaign) and whether donors can receive a charitable contribution deduction, many campaigns are not so transparent.
Attorneys general in several states have taken notice of crowdfunding platforms and have issued statements and guides about the rules applicable to nonprofits and crowdfunding sites. They have also cautioned donors to question the veracity of personal campaigns before donating.
Whether or not crowdfunding operators should be subject to specific regulations, and their responsibilities defined, are questions to consider as crowdfunding continues to grow. Although existing consumer protection and fraud laws offer some protection, the law has clearly not caught up with the technology and the prevalence of charitable crowdfunding. For now, donors, crowdfunding sites, and regulators should pay careful attention to the millions raised for the Orlando victims, and ensure that funds are given to the proper beneficiaries.