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I used crowdfunding for my startup. What happens if my business fails?

So you have a really cool idea for a startup, but you don’t have the money you need to launch it. Your last $5 paid for two slices of pizza last night. You’re certain your product will be a hit though, something that will make money and leave everyone talking for years to come. A bank loan is out of the question. What now?

Then, a solution hits you: Crowdfunding.

Crowdfunding was a $34 billion industry in 2015, according to Forbes. It’s helped open bike shops, produced record albums, and launched software companies..

Crowdfunding works like this, people list what they are raising money for and typically offer reward tiers in exchange for donations. A musician might promise downloads of his album or T-shirts, for example, if someone contributes certain amounts to his campaign.

You launch a crowdfunding campaign. Donations from the start are good — almost too good. As production of your product begins, and hits a few snags, you worry about this whole thing falling apart. Will you have to pay donors back if your idea fails? You don’t want to let them down, or be a pessimist, but understand that you should be prepared for the unthinkable.

The reality is, in entrepreneurship, failure does happen.

In March 2011, a Brooklyn, New York, entrepreneur launched a successful crowdfunding campaign to raise money for a standing iPad mount. He raised $35,000. Product production was a disaster, however, and he was unable to fulfill a promise to his backers that they’d receive the mount once it was done.

One of those backers, who had contributed $70 to the campaign, sued. The lawsuit ultimately caused the entrepreneur to file bankruptcy.

The lawsuit is a worst-case scenario, but something entrepreneurs who launch crowdfunding campaigns need to consider. Most crowdfunding sites tell those who use them that they will have to pay back contributors in the event they cannot fulfill a reward.

 There are steps you can take to help protect yourself against litigation. For starters, become a corporation. The entrepreneur from Brooklyn didn’t incorporate before he got a crowdfunding account, so he was on his own when his idea went south.

Seek the advice of an experienced corporate attorney who can help you protect yourself, especially if things don’t work out the way you plan. That way, you can pick yourself up and move on to your next venture.

Each business and business entity is unique. To understand the different options and which direction will be best for your situation, you need to consult with an experienced corporate attorney. Michael Leonard, Esq., of San Diego Corporate Law, named “Best of the Bar” by the San Diego Business Journal in 2016, has the expertise to guide you through everything from forming your business, to creating buy-sell agreements, to executing contracts and anything in between. To schedule a consultation to discuss any business-related matter, please contact Mr. Leonard by visiting San Diego Corporate Law or by telephone at (858) 483-9200.

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