How to Properly Document Money Your Business Receives
Know how to document loans and equity investments in your business.
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When raising money for your business from through loans, equity investors, or gifts, it’s important to document what you’ve received. The form of documentation will vary depending on where the money is coming from.
An unsecured loan is a loan you obtain without having to provide collateral or “security.” You might obtain this sort of loan from a bank. Alternatively, you might find another commercial lender, or even a private individual, who will give you an unsecured loan.
The key document for an unsecured loan is the promissory note. A promissory note should lay out the basic conditions of the loan, such as the number and amount of monthly installment payments you are agreeing to make, and what interest rate is being charged. It may also include other conditions of the loan, such as fees for late payments and whether you can pay in advance without a penalty. If you’re getting an unsecured loan from a bank, the bank itself will have its own promissory note form.
Make sure you sign only one promissory note for a loan; additional, signed copies can cause legal confusion about whether more than one loan is involved.
With a secured loan, you are pledging some sort of collateral or security against the loan. If you fail to meet the terms of the loan, the lender ultimately will have the right to seize that security.
A secured loan, like an unsecured loan, should include a promissory note. However, the promissory note for a secured loan should include additional language indicating that the loan is secured, and that there are additional documents regarding the lender’s rights in regard to the collateral. If you’re dealing with a bank or similar institutional lender, then the lender should have the relevant documents.
Documentation will vary depending on what kind of asset you are using for security. If you are using personal property, such as business equipment or inventory, you should expect to fill out and sign a document where you agree that the lender can take that property if you fail to repay the loan. You can also expect that the lender will ask you to sign a financing statement as specified under the Uniform Commercial Code (UCC). Sample versions of this document, commonly known as Form UCC-1, are readily available online. Once you’ve completed the UCC-1, the lender will file it with a local government office to provide notice to the public that the lender has a claim or “lien” on your property. Once you’ve paid off the loan, you should make sure the lender releases the lien.
A loan secured with real estate is more complicated than one secured with personal property. It will involve more specialized documentation than a promissory note and a Form UCC-1, and you may need to consult a lawyer for assistance. When the time comes to sign, you will need witnesses and notarization. As with a loan secured by personal property, documentation will be filed with a government office to provide public notice of a lien on your real estate. And, as with other types of secured loans, you will want to make sure that the lien is removed when you pay off the loan. With real estate, it’s particularly important not to have some blemish on the title, which might cause problems with a future sale of the property.
An equity investment involves a person giving you money in exchange for an ownership interest in your business. Depending on how your business is structured, this may more specifically mean that the investor receives shares of stock in the business, or is now legally a partner in your business.
In the case of corporations, limited liability companies, and partnerships, equity investments are usually considered to be securities, and therefore are subject to certain federal and state laws. Those laws require some businesses to file a variety of documents with the government. If your business is “closely-held”—meaning most of its shares are held by a small number of people—then you should be able to avoid much of the securities paperwork. Otherwise, you should seek expert counsel on meeting your securities filing requirements.
As a separate issue, you should always have some written agreement with an equity investor. The exact form of agreement will depend on the legal form of your business:
- for a corporation, an equity investor will be a shareholder, and should sign a shareholders’ agreement;
- for a partnership, an equity investor will be a partner, and you should properly modify, and then all the partners should sign, the partnership agreement; and
- for a limited liability company (LLC), an equity investor will be a “member,” and all members should sign (or, as appropriate, amend and sign) the LLC’s operating agreement.
If you’re lucky enough to have someone give you money for your business as a gift, it’s still appropriate, though not legally required, that you prepare some kind of documentation. One reason for documenting a gift is to avoid later arguments; for example, you may think that money given to you by a parent was obviously a gift, but later find that a sibling always thought otherwise, leading to an unexpected legal dispute. Also, by documenting a gift, you can avoid wrangling with the IRS over whether the money was really a loan, and is therefore taxable; the IRS does not tax monetary gifts up to $13,000.
This article touches on just a few areas where you may bring money into your business in order to keep it running. There are many other sources you might rely on to raise money for your business and those sources will require their own forms of documentation. For more complete information on documenting money received, consider consulting Legal Guide for Starting & Running a Small Business, by Fred Steingold (Nolo) and Tax Savvy for Small Business, by Frederick Daily (Nolo).