Legal Forms for Starting & Running a Small Business
Fred S. Steingold, Attorney
March 2014, 8th Edition
Save your business time and money
As a small business owner, you can't afford to farm paperwork and contracts out to a lawyer—you have to deal with them yourself. With Legal Forms for Starting & Running a Small Business, you can act with confidence.
Here you’ll find over 60 of the most important forms you need to run your small business, as well as thorough, plain-English, line-by-line instructions for using them. You’ll be able to:
- write contracts
- hire employees and consultants
- protect your trade secrets
- create noncompete agreements
- prepare corporate bylaws
- prepare an LLC operating agreement
- record minutes of meetings
- borrow and lend money
- buy a business
- lease commercial space
- buy real estate, and
- and much more
The new 8th edition has been thoroughly reviewed and updated by Nolo’s experts, and provides the most up-to-date legal information for small businesses.
“Balances its wealth of reproducible documents with straightforward ‘how-to’ instructions and advice...”
“Two things make this work exceptionally valuable. First, the forms and contracts are written in straightforward language [and] all of the forms can be found on a CD-ROM that comes with the book.”
-American Reference Books Annual
“Provides instructions for completing the contracts required when forming a corporation, borrowing money, buying a business, leasing an office, hiring employees and selling goods.”
-Reference & Research Book News
- Attachment to Contract
- Amendment to Contract
- Checklist for Starting a Small Business
- Partnership Agreement
- Pre-Incorporation Agreement
- Corporate Bylaws
- Stock Agreement
- LLC Operating Agreement for Single-Member LLC
- Notice of Shareholders' Meeting
- Notice of Directors' Meeting
- Shareholder Proxy
- Minutes of Shareholders' Meeting
- Minutes of Directors' Meeting
- Minutes of Telephone Conference Directors' Meeting
- Consent of Shareholders
- Consent of Directors
- Promissory Note (Amortized Monthly Payments)
- Promissory Note (Balloon Payment)
- Promissory Note (Interest-Only Payments)
- Promissory Note (Lump Sum Payment)
- Security Agreement for Borrowing Money
- Contract for Purchase of Assets From an Unincorporated Business
- Contract for Purchase of Assets From a Corporation
- Corporate Resolution Authorizing Sale of Assets
- Contract for Purchase of Corporate Stock
- Bill of Sale for Business Assets
- Seller's Affidavit: No Creditors
- Security Agreement for Buying Business Assets
- Gross Lease
- Net Lease for Entire Building
- Net Lease for Part of Building
- Landlord's Consent to Sublease
- Assignment of Lease
- Notice of Exercise of Lease Option
- Extension of Lease
- Amendment to Lease
- Attachment to Lease
- Contract to Purchase Building
- Option to Purchase Building
- Contract to Purchase Vacant Land
- Option to Purchase Vacant Land
- Attachment to Real Estate Purchase Contract
- Amendment to Real Estate Purchase Contract
- Removal of Contingency
- Extension of Time to Remove Contingencies
- Exercise of Option to Purchase Real Estate
- Sales Contract (Lump-Sum Payment)
- Sales Contract (Installment Payments)
- Bill of Sale for Goods
- Security Agreement for Buying Goods
- Contract for Manufacture of Goods
- Equipment Rental Contract
- Storage Contract
- Consignment Contract
- Employment Application
- Authorization to Release Information
- Offer of Employment
- Confidentiality Agreement
- Covenant Not to Compete
- Contract With Independent Contractor
- IRS Form SS-4: Application for Employer Identification Number
- IRS Form W-4: Employee's Withholding Allowance Certificate
- IRS Form 2553: Election by a Small Business Corporation
- IRS Form 940-EZ
- IRS Form 940: Employer’s Annual Federal Unemployment (FUTA) Tax Return
- USCIS Form I-9: Employment Eligibility Verification
- Disputes Resolution Clause
- Names Formats
- Signature Formats
Forming Your Business
Running Your Corporation
Buying or Selling a Business
Purchasing and Improving Real Estate
Buying, Selling, Manufacturing, Renting, and Storing Goods
Hiring Employees and Independent Contractors
IRS and Government Forms
The following forms are included in the download, but not included in the book:
Fred S. Steingold
Attorney Fred S. Steingold practices law in Ann Arbor, Michigan. An expert on small business law, he represents and advises many small businesses. He is the author of Legal Guide for Starting & Running a Small Business and The Employer's Legal Handbook. His monthly column, "The Legal Advisor," is carried by trade publications across the country.
Your Small Business Legal Companion
- Four Practical Ways to Use the Forms in This Book
- Do You Need a Lawyer?
1. Contract Basics
- Names Clause: Identifying the Parties to a Contract
- Signature Clause: Signing a Contract
- Standard Clauses
- Resolving Disputes
2. Forming Your Business
- Form 2A: Checklist for Starting a Small Business
- Form 2B: Partnership Agreement
- Form 2C: Preincorporation Agreement
- Form 2D: Corporate Bylaws
- Form 2E: Stock Agreement
- Form 2F: LLC Operating Agreement for Single-Member LLC
- Form 2G: LLC Membership Certificate
- Form 2H: Stock Certificate
3. Running Your Corporation
- Form 3A: Notice of Shareholders’ Meeting
- Form 3B: Notice of Directors’ Meeting
- Form 3C: Shareholder Proxy
- Form 3D: Minutes of Shareholders’ Meeting
- Form 3E: Minutes of Directors’ Meeting
- Form 3F: Minutes of Telephone Conference Directors’ Meeting
- Form 3G: Consent of Shareholders
- Form 3H: Consent of Directors
4. Borrowing Money
- Understanding Promissory Notes in General
- The Promissory Notes in This Chapter
- Form 4A: Promissory Note (Amortized Monthly or Annual Payments)
- Form 4B: Promissory Note (Balloon Payment)
- Form 4C: Promissory Note (Interest-Only Payments)
- Form 4D: Promissory Note (Lump-Sum Payment)
- Form 4E: Security Agreement for Borrowing Money
5. Buying a Business
- Form 5A: Contract for Purchase of Assets From an Unincorporated Business
- Form 5B: Contract for Purchase of Assets From a Corporation
- Form 5C: Corporate Resolution Authorizing Sale of Assets
- Form 5D: Contract for Purchase of Corporate Stock
- Form 5E: Bill of Sale for Business Assets
- Form 5F: Seller’s Affidavit—No Creditors
- Form 5G: Security Agreement for Buying Business Assets
6. Leasing Space
- Form 6A: Gross Lease
- Form 6B: Net Lease for Entire Building
- Form 6C: Net Lease for Part of Building
- Form 6D: Sublease
- Form 6E: Landlord’s Consent to Sublease
- Form 6F: Assignment of Lease
- Form 6G: Notice of Exercise of Lease Option
- Form 6H: Extension of Lease
- Form 6I: Amendment to Lease
- Form 6J: Attachment to Lease
7. Purchasing Real Estate
- Beware of Possible Environmental Problems
- Form 7A: Contract to Purchase Building
- Form 7B: Option to Purchase Building
- Form 7C: Contract to Purchase Vacant Land
- Form 7D: Option to Purchase Vacant Land
- Form 7E: Attachment to Real Estate Purchase Contract
- Form 7F: Amendment of Real Estate Purchase Contract
- Form 7G: Removal of Contingency
- Form 7H: Extension of Time to Remove Contingencies
- Form 7I: Exercise of Option to Purchase Real Estate
8. Buying, Selling, Manufacturing, Renting, and Storing Goods
- Form 8A: Sales Contract (Lump-Sum Payment)
- Form 8B: Sales Contract (Installment Payments)
- Form 8C: Bill of Sale for Goods
- Form 8D: Security Agreement for Buying Goods
- Form 8E: Contract for Manufacture of Goods
- Form 8F: Equipment Rental Contract
- Form 8G: Storage Contract
- Form 8H: Consignment Contract
9. Hiring Employees and Independent Contractors
- Form 9A: Employment Application
- Form 9B: Authorization to Release Information
- Form 9C: Offer of Employment
- Form 9D: Confidentiality Agreement
- Form 9E: Covenant Not to Compete
- Form 9F: Contract With Independent Contractor
10. Extending Credit and Getting Paid
- Form 10A: Credit Application for an Individual Customer
- Form 10B: Adverse Action Letter
- Form 10C: Credit Application for a Business Customer
- Form 10D: First Collection Letter
- Form 10E: Second Collection Letter
- Form 10F: Third Collection Letter
A. How to Use the Electronic Forms
- Editing RTFs
- List of Forms
Forming Your Business
Form 2A: Checklist for Starting a Small Business.......................................... 30
Evaluate and Develop Your Business Idea................................................ 30
Decide on a Legal Structure for Your Business......................................... 31
Choose a Name for Your Business........................................................... 31
Prepare Organizational Paperwork........................................................... 31
Find a Business Location......................................................................... 33
File for Licenses and Permits .................................................................. 34
Obtain Insurance..................................................................................... 34
Set Up Tax Reporting and Accounting...................................................... 35
Hire Workers........................................................................................... 36
Form 2B: Partnership Agreement.................................................................. 38
Form 2C: Preincorporation Agreement.......................................................... 45
Form 2D: Corporate Bylaws.......................................................................... 50
Form 2E: Stock Agreement........................................................................... 55
Form 2F: LLC Operating Agreement for Single-Member LLC.......................... 58
Form 2G: LLC Membership Certificate.......................................................... 62
Form 2H: Stock Certificate........................................................................... 63
When you start a new business, you must choose a legal format. For most small businesses, the choices come down to these:
regular corporation (sometimes called a C corporation)
S corporation, or
limited liability company (LLC).
Other legal formats—limited partnership, professional corporation, and nonprofit corporation—are unlikely to meet the needs of the typical small business.
If you start a one-person business or work as a freelancer or independent contractor, your business will automatically be treated as a sole proprietorship unless you establish a corporation or an LLC. Similarly, if you start a business with two or more people, your business will automatically be treated as a general partnership unless you form a corporation, an LLC, or a limited partnership.
The most important factors in deciding which way to go are:
Personal Liability. Will you be personally liable for business debts? (Personal liability means that a business creditor—a person or company to whom your business owes money—can get a judgment against you for the debt. The creditor can then collect the judgment out of your personal assets such as a personal bank account or your home.) The fast answer is that as a sole proprietor or a partner, you’ll face personal liability for business debts. But as the owner of shares in a corporation or as a member of an LLC, you’ll generally face no personal liability—unless, of course, you voluntarily agree to assume it by signing a personal guarantee (such as for a business loan).
Limited liability isn’t a big deal for many microbusinesses. A great many small service and retail businesses simply don’t subject their owners to significant debt or lawsuit risk. And often even in the few cases where they do, a good insurance policy will provide needed protection. This means that there’s often no compelling need to form a corporation or an LLC when you’re just starting out.
Taxes. Will you and the other business owners simply report your portion of profits and losses on your own income tax returns, or will the business itself be taxed on its profits? Sole proprietors, partners, owners of S corporation stock, and members of LLCs need only contend with one level of taxation: All taxes are paid by the owners on their individual returns. By contrast, a regular or C corporation pays taxes on its corporate earnings in addition to the taxes paid by the shareholders who receive dividends.
Sometimes being taxed twice is cheaper. Although you’d think that being subject to the income tax at both the corporate and personal levels would be more expensive than being taxed once on all business income on your personal return, you’d sometimes be wrong. Because the initial federal income tax rates are lower for incorporated businesses than for individuals, and because businesses often prefer not to pay out all earnings to owners, but instead want to keep money in the business from one year to the next (for example, to pay for future expansion), operating as a regular corporation can result in tax savings. This usually applies only to companies that have been in business a few years and have become profitable.
Time and Expense. Will it be time-consuming and costly to form and maintain the business? Sole proprietorships and partnerships are relatively easy and inexpensive to start and keep up. Corporations and LLCs typically require more time and effort and cost a bit more—but the cost needn’t be a tremendous burden. You can handle all or most of the paperwork yourself by using one of the Nolo books listed below.
Fringe Benefits. Will the business be able to provide fringe benefits (health insurance, retirement plans, and the like) to the owners and deduct the cost of those benefits as a business expense? This question is only relevant to businesses with enough income to pay fairly generous fringe benefits in the first place. But if your business is lucky enough to be in this category, the regular C corporation offers the best tax-saving opportunities.
Form Your Entity Online
With Nolo’s Online Legal Forms, forming your LLC or corporation can be quick and easy. You’ll complete a comprehensive interview about you and your business. Then Nolo will file the necessary forms.
To start your LLC formation now, go to
www.nolo.com/products/business-formation/online-llc-filing. To start your corporation formation now, go to www.nolo.com/products/business-formation/online-corporation.
For in-depth information on choosing a legal format for your business, see Chapter 1 of Legal Guide for Starting & Running a Small Business, by Fred S. Steingold (Nolo). For specifics and useful forms to create various types of business entities, see the following publications from Nolo:
Form Your Own Limited Liability Company, by Anthony Mancuso, shows you how to establish an LLC in all 50 states.
Incorporate Your Business: A Legal Guide to Forming a Corporation in Your State, by Anthony Mancuso, shows you how to form a corporation in all 50 states.
Form a Partnership: The Complete Legal Guide, by Denis Clifford and Ralph Warner, shows you how to form a partnership and create a lasting partnership agreement.
It’s often smart to start with the simplest legal format and convert later if necessary. It can be eminently sensible to start out as a simple, inexpensive sole proprietorship or partnership. Later you can convert to a corporation or an LLC if your risk of personal liability increases or there are compelling tax reasons to do so.
To guide you through the steps you must take to form any type of business, read Form 2A: Checklist for Starting a Small Business.
The other forms in this chapter help you start a partnership, a corporation, or a one-owner LLC. No formal document is required to start a sole proprietorship. However, there are several practical and legal steps you must take to put your business on the right track. (This is covered in Form 2A: Checklist for Starting a Small Business, mentioned above.)
Partnerships. If you are starting a partnership, preparing a written partnership agreement allows you to provide a sound footing for your legal relationship with your partners and helps prevent or resolve disputes that may later arise. Use Form 2B: Partnership Agreement for this purpose.
Limited Liability Companies (LLCs). Many business owners who want to limit their personal liability prefer the simplicity and flexibility of the LLC over the corporation. To form an LLC, owners must file articles of organization with the state and sign an operating agreement. If you are starting an LLC and you will be its sole owner, you can use Form 2F: LLC Operating Agreement for Single-Member LLC to help preserve your limited liability status. (This book does not provide an operating agreement for multimember LLCs; however, the instructions for Form 2A: Checklist for Starting a Small Business gives other resources for multimember LLCs.) If you wish to give each member of your LLC a document showing his or her ownership interest in the company, you can use Form 2G: LLC Membership Certificate.
Corporations. If you decide to form a corporation, this book offers three useful documents for this purpose. Before forming the corporation, it’s sensible to have all shareholders agree in advance on the basic elements of the business, including the name and purpose of the corporation, how many shares each owner will acquire, and who will serve on the board of directors. Use Form 2C: Preincorporation Agreement to record this information.
To form the corporation, owners must file articles of incorporation with the state and create corporate bylaws. Form 2D: Corporate Bylaws lays out the legal rules for running the corporation and covers such matters as how many people will serve on the board of directors, when and where regular meetings will be held, who may call a special meeting, and what officers the corporation will have.
Unless all shareholders create an agreement to restrict the sale or transfer of their shares, any shareholder can freely transfer them. Free transfer is okay for publicly traded stock but can create havoc in a small corporation where the shareholders (owners) usually run the business. If you’re in business with two other owners, for example, you probably wouldn’t want Owner #3 to sell his or her stock to a complete stranger, because the new person may have a completely different vision about how to run the company. Accordingly, Form 2E: Stock Agreement allows you to provide in advance what will happen if a shareholder wants to transfer shares or dies.
Finally, with Form 2H: Stock Certificate, you can give each shareholder a document showing his or her ownership interest in the corporation.
Form 2A: Checklist for Starting a Small Business
This checklist makes a great to-do list for starting your business.
Instructions for Form 2A: Checklist for Starting a Small Business
All the forms in this book are provided in Appendix B and electronically on the Nolo website. To access the eforms online, use the link provided in Appendix A.
Evaluate and Develop Your Business Idea
First, before you invest a lot of time and money in your business idea, you should determine if you’ve chosen the right business and if the business can make money. If you pass these tests, it’s time to do some initial planning and brainstorming. Next you should create a business plan, consider sources of financing, and think about a basic marketing plan.
Analyze Your Business Idea. To determine if your business idea makes sense for you, you may want to read “Start the Right New Business for You,” a free article on Nolo’s website (www.nolo.com).
Can Your Business Make Money? To determine if your business can be profitable, you should do a break-even analysis with expense and sales estimates. To learn how, read “Will My Business Make Money?”—a free article on Nolo’s website (www.nolo.com).
Creating a Business Plan. Creating a business plan is important even if you won’t be seeking outside money from banks or investors. For more information on developing your business plan, including how to create a profit/loss forecast and a cash flow analysis, see Nolo’s book How to Write a Business Plan, by Mike McKeever.
Getting Loans or Equity Investments. To explore ways to raise money for your small business, read Legal Guide for Starting & Running a Small Business, by Fred S. Steingold (Nolo), Chapter 9. If you decide to borrow money from friends or family members (rather than a bank or other financial institution), see Chapter 4 of this book for promissory notes you can use to specify the details of the payment arrangements.
Market Your Idea. For information on setting up a marketing plan, see Marketing Without Advertising: Easy Ways to Build a Business Your Customers Will Love & Recommend, by Michael Phillips & Salli Rasberry (Nolo). This book includes worksheets to help you create a marketing list and design marketing events.
Decide on a Legal Structure for Your Business
Next, you need to decide what type of ownership structure you’ll choose; that is, whether you’ll operate your business as a sole proprietorship, a partnership, a corporation, or an LLC.
Most business owners start out as sole proprietors, or if there are two owners involved, as a partnership. If their businesses are successful, they may consider becoming a corporation or an LLC.
Whether you’re better off starting as a sole proprietor or partnership or choosing one of the more sophisticated organizational structures depends on several factors, including the size and profitability of your business, how many people will own it, and whether it will entail liability risks not covered by insurance.
To learn more about the various legal structures, see Legal Guide for Starting & Running a Small Business, by Fred S. Steingold (Nolo), Chapter 1.
Choose a Name for Your Business
Before you settle on a name for your business, you’ll need to determine if your proposed name is available for your use. Once you find an available name, you’ll have to register it as a fictitious or assumed business name, a corporate or an LLC name, if applicable, and possibly as a federal and state trademark.
Finding an Available Business Name. Before using a business name, it’s wise to conduct a name search to avoid a conflict with a business that’s already using the same or a similar name. If you’re starting a small, local business, you can usually feel reasonably secure searching for name conflicts at the state and local level. If you’re starting a larger company or one that will do business in more than one state, you may need to do a more sophisticated federal trademark search. For more information on doing name searches, see Legal Guide for Starting & Running a Small Business, by Fred S. Steingold (Nolo), Chapter 6.
Registering Your Business Name. In most states, if you do business under a name other than your own legal name, you’ll need to register it as a fictitious or assumed name.
If you’re forming a corporation or an LLC, you’ll register your business name with the office of the secretary of state or other agency when you file your articles of incorporation or articles of organization.
In addition, if you plan to do business regionally or nationally and will use your business name to identify a product or service, you should also look into registering your trademark or service mark at the state or federal level.
For more information on registering your business name, see Legal Guide for Starting & Running a Small Business, by Fred S. Steingold (Nolo), Chapter 6. You may also want to see Trademark: Legal Care for Your Business & Product Name, by Stephen Elias and Richard Stim (Nolo).
Prepare Organizational Paperwork
If you’ve decided to start out as a sole proprietor, you can skip this checklist item and jump ahead to “Find a Business Location.”
If you’ve decided to create a partnership, an LLC, or a corporation, you’ll need to take an extra step or two. For example, partners need to form a partnership agreement, LLC members need to create articles of organization, and corporate shareholders need to fill out articles of incorporation.
Partnerships. Partners should sign a written partnership agreement before going into business together. For more information on forming a partnership, see Legal Guide for Starting & Running a Small Business, by Fred S. Steingold (Nolo), Chapter 2.
Limited Liability Companies. To form an LLC, owners must file articles of organization and sign an operating agreement. For more information on forming an LLC, see Legal Guide for Starting & Running a Small Business, by Fred S. Steingold (Nolo), Chapter 4.
If you will be the sole owner of your LLC, you can use Form 2F: LLC Operating Agreement for Single-Member LLC.
Corporations. To form a corporation, incorporators must files articles of incorporation—which in some states are called certificates of incorporation, articles of association, or charters. In many states, the secretary of state can give you a printed form for this essential document—or you may find the form online; all you have to do is fill in some blank spaces. In other states, you must start from scratch. Although details vary from state to state, you’ll typically include:
the corporation’s name
the name of the initial agent for service of process (sometimes called a registered agent or resident agent)
the number of shares authorized, and
the names and addresses of the incorporators.
You’ll file the form with the secretary of state (or other designated official) and pay an incorporation fee. In addition, your corporation will need to adopt bylaws. When you’re ready, use Form 2C: Preincorporation Agreement, Form 2D: Corporate Bylaws, and Form 2E: Stock Agreement. For more information on forming a corporation, see Legal Guide for Starting & Running a Small Business, by Fred S. Steingold (Nolo), Chapter 3.
S Corporations. If you decide to form an S corporation, in addition to the regular corporate paperwork mentioned above, you’ll also need to file IRS Form 2553, Election by a Small Business Corporation. For more information on S corporations, see Legal Guide for Starting & Running a Small Business, by Fred S. Steingold (Nolo), Chapter 3.
Find a Business Location
Unless you’ll start out running your business from home (which many sole proprietors do indefinitely), you’ll want to find suitable commercial space.
Identifying Your Needs. When choosing business space, you need to consider the size of the premises, the availability of customer parking, and the status of electrical and communications wiring, among other things. For help on identifying your minimum requirements and the maximum rent you can pay for your business space, see Legal Guide for Starting & Running a Small Business, by Fred S. Steingold (Nolo), Chapter 1.
Finding a Location. One key to choosing a profitable location is determining the factors that will increase customer volume for your business. For more information on looking for a location and using a broker, see Negotiate the Best Lease for Your Business, by Janet Portman and Fred S. Steingold (Nolo), Chapter 2.
Negotiating Your Lease. With a little effort, you can usually negotiate significant improvements to the landlord’s lease terms. For lots of helpful information on negotiating lease terms, see Negotiate the Best Lease for Your Business, beginning at Chapter 5. To create your own lease, see Chapter 6 of this book for a number of forms you can use.
Home Businesses. Following are a few issues that concern most home businesses—in most cases, a few precautions are all that’s needed to avoid unexpected legal difficulties. For more information, see Legal Guide for Starting & Running a Small Business, by Fred S. Steingold (Nolo), Chapter 14.
Insurance. Make sure you have adequate liability and property damage insurance; your homeowners’ insurance policy may not cover business use of your home. For example, if a UPS delivery person trips on your porch step while delivering a business package to you or if your dog bites a visiting client, you may not be covered. Similarly, you may find that homeowners’ coverage won’t pay for a business computer that gets stolen. An insurance agent or broker can probably extend your policy to cover your business use for a modest additional premium.
Lease and Homeowner Restrictions. Be aware that you may not have an unlimited right to do business from your home. If you’re in a rented unit, your lease may prohibit business operations. In a private home, you may be bound by “covenants, conditions, and restrictions”—rules that apply to all owners in a subdivision, condo, or planned-unit development.
Review Zoning Ordinances. Local zoning ordinances may not allow businesses to operate in the district where you live. Learn about the local zoning restrictions; you may be able to abide by them, or at least meet their spirit. Or, you may need to get a home occupation permit for your business. Check with your local zoning or planning office. A neighbor or municipal zoning ordinance will probably not stop your business use if you keep a low profile. Limit your signage, keep deliveries to a minimum, and don’t see too many customers or clients at your home. Neighbors are unlikely to complain if you run a quiet, low-traffic business that doesn’t affect them.
Taxes. Taxes—especially the rules on the home-office deduction and depreciation—are another concern for home-based businesses. You should review IRS Publication 587, Business Use of Your Home. This publication is available from the IRS website at www.irs.gov. For more information on taxes for home businesses, see Home Business Tax Deductions, by Stephen Fishman (Nolo).
File for Licenses and Permits
You will need to complete general business registration requirements. You may have to obtain a business license from your municipality, an employer identifi-cation number from the IRS, a seller’s permit from your state, a zoning permit from your local planning board, and other licenses or permits.
Federal Taxpayer Identification Number. If you are forming a partnership or corporation or your business will hire employees, you need to obtain a taxpayer ID from the IRS. You can use IRS Form SS-4, Application for Employer Identification Number, included in this book.
Licenses. In most locations, every business needs a basic business license, or tax registration certificate. And, in addition to a basic business license, you may need a specialized business license—especially if you sell food, liquor, or firearms or work with hazardous materials. States also require licensing of people practicing traditional professions, such as lawyers, physicians, pharmacists, and architects and may require licenses for other occupations, such as barbers, auto mechanics, pest control specialists, and insurance agents—the list varies from state to state.
Permits. In addition to a business license, you may need a zoning permit or variance to carry on your intended business. And if you plan to run a regulated business, such as a restaurant, bar, taxi service, or waste removal company, you’ll probably need a special permit from state or local authorities. Again, the list varies from location to location so you’ll need to inquire with the appropriate municipal and state offices.
Your state’s Small Business Development Center or other agency may offer a one-stop shopping website that advises you on the licenses and permits you need for your particular type of business. To learn more about licenses and permits, see Legal Guide for Starting & Running a Small Business, by Fred S. Steingold (Nolo), Chapter 7. You may also want to see The Small Business Start-Up Kit: A Step-by-Step Legal Guide or The Small Business Start-Up Kit for California, both by Peri H. Pakroo (Nolo).
Although business insurance is not generally required, it’s a good idea to purchase enough insurance to cover your company’s assets.
Property Insurance. It’s sensible to carry insurance to replace or repair your property if it’s stolen or damaged by fire, flood, windstorm, earthquake, vandalism, or any of dozens of other hazards. The insurance should also cover the theft of, or damage to, property that a customer leaves in your care—for example, a valuable piece of equipment.
Liability Insurance. You want the peace of mind of knowing that you have liability coverage in case someone is physically injured on your premises (slipping on a wet floor, for example) or as a result of your business operations (getting struck by a company van). Be sure you’re also covered if an employee driving his or her own car injures someone while on company business. And if you’ll be manufacturing a product or selling dangerous items, look into product liability insurance so you’re protected if a product you’ve made or sold injures someone.
Other Insurance Coverage. Review your business operations with an experienced insurance agent or broker to learn what other coverage may be appropriate. There’s no substitute for establishing a good working relationship with a knowledgeable insurance agent or broker. For more information on obtaining insurance, see Legal Guide for Starting & Running a Small Business, by Fred S. Steingold (Nolo), Chapter 12.
Set Up Tax Reporting and Accounting
Before the end of your first year, you’ll need to learn how to report your income, which may vary depending on how your business is structured. To optimize your tax savings, you should become familiar with how to write off expenses and asset purchases as well as keep good records—before you start to incur start-up costs.
How Your Business Is Taxed. To learn about taxes for sole proprietors, see Tax Savvy for Small Business, by Frederick W. Daily and Jeffrey A. Quinn (Nolo), Chapter 7.
To learn about partnership taxation, see Chapter 10 of that book.
To learn about corporate taxation, see Chapters 8 and 9.
To learn about LLC taxation, see Chapter 11.
Deductions and Depreciation. Just about any necessary and reasonable expense that helps you earn business income is deductible. For information on deducting expenses, see Tax Savvy for Small Business, Chapter 2. You’ll also find excellent guidance in another Nolo book, Deduct It! Lower Your Small Business Taxes, by Stephen Fishman. Special rules apply to deducting the cost of business equipment and assets, which usually must be depreciated over a number of years. See Chapter 3 of that book for more information.
IRS Publications. Form 2A alerts you to two IRS publications about federal taxes for small businesses, as well as a helpful tax calendar with important filing dates. You can get these publications from the IRS website (www.irs.gov).
Record Keeping and Accounting. You’ll need to decide on a method of accounting, a tax year, and a method of bookkeeping.
Cash vs. Accrual Accounting. Most small service businesses use the cash method of accounting, but if your business will stock inventory to sell to the public or use in manufacturing, the IRS requires you to use the accrual accounting method. For information about the difference between cash and accrual accounting, see Tax Savvy for Small Business, Chapter 4.
Calendar vs. Fiscal Year. Most small businesses use a calendar year (January 1 to December 31). To choose another tax period, you must have a good reason and get permission from the IRS. For information about choosing a calendar or fiscal year, see Tax Savvy for Small Business, Chapter 4. To choose a tax period other than the calendar year, use IRS Form 8716, Election to Have a Tax Year Other Than a Required Tax Year.
Bookkeeper vs. Software. Depending on the volume and complexity of your business finances, you may benefit from hiring a part-time bookkeeper or consulting an accountant who can show you how to set up a simple bookkeeping system. Or, you may find that business accounting software, such as Quicken Home and Business or QuickBooks (both by Intuit) will be sufficient. For information on bookkeeping, see Tax Savvy for Small Business, Chapter 4.
Chances are you may need to hire employees or independent contractors before long, if not right off the bat.
General Information on Hiring Workers. The Employer’s Legal Handbook, by Fred S. Steingold (Nolo), provides excellent information on wage and hour laws, antidiscrimination statutes, and leave policies. You’ll find additional help in another Nolo publication, Hiring Your First Employee, by Fred S. Steingold. Below you’ll also find a discussion of employment forms included in this book, as well as links to government agencies and important websites.
Independent Contractors. When you’re just starting out, hiring independent contractors can save a lot of time and money. However, you need to be careful not to mistakenly or falsely characterize workers as independent contractors. To qualify as an independent contractor under IRS rules, a worker must control both the outcome of a project and the means of accomplishing it. In close cases, the IRS prefers to see workers treated as employees rather than as independent contractors. For more information on the difference between independent contractors and employees, see The Employer’s Legal Handbook, Chapter 12. If you decide to hire an independent contractor, use Form 9F: Contract With Independent Contractor.
Employer Identification Numbers. If you don’t have an Employer Identification Number (EIN) already, you’ll need one when you pay employer and employee income taxes, Social Security taxes, and Medicare taxes. The easiest way to get an EIN, is to apply for one online using the question-and-answer feature available at www.irs.gov. Or, if you prefer, you can phone in the information or fill out a paper version which you can mail or fax to the IRS. See www.irs.gov for details. We’ve included the form, IRS Form SS-4 Application for Employer Identification Number, in this book and on Nolo’s website (see Appendix A).
Unemployment Tax. You’ll have to make payments to your state’s unemployment compensation fund, which provides short-term relief to workers who are laid off. First, you’ll need to register with your state’s employment department or similar agency. To find the proper agency, go to www.statelocalgov.net.
You’ll also need to file IRS Form 940 Employer’s Annual Federal Unemployment (FUTA) Tax Return to report your federal unemployment tax each year. You must file this form for any year in which:
you paid wages of $1,500 or more in any quarter, or
had one or more employees for at least part of a day in any 20 or more different weeks. Count all full-time, part-time, and temporary employees, but don’t count partners if your business is a partnership.
Form 940 is included in this book and on Nolo’s website. It’s also available from the IRS website (www.irs.gov).
Withholding and Payroll Taxes. Every business with employees must withhold a portion of each employee’s income and deposit it with the IRS, and also make Social Security and Medicare tax payments to the IRS. Have each new employee fill out IRS Form W-4, Employment Withholding Allowance, included in this book. This form does not need to be filed with the IRS, but it tells you how many allowances an employee is claiming for tax purposes, so that you can withhold the correct amount of tax from his or her paycheck. For more information, be sure to get IRS Publication 15, Circular E, Employer’s Tax Guide. You can get this publication from the IRS website (www.irs.gov).
Workers’ Compensation. Look into the workers’ compensation insurance requirements in your state. You’ll need this coverage in case a worker suffers an on-the-job injury, because such injuries aren’t covered by normal liability insurance. To find your state agency’s website, go to www.irmi.com/resources/categories/statewcagencies.aspx. For more information on workers’ compensation laws, see The Employer’s Legal Handbook, Chapter 7.
Compliance With Other Government Regulations. Several federal and state agencies administer other laws in the workplace. Be sure to comply with the laws of each agency:
OSHA. For information on compliance with Occupational Safety and Health Administration (OSHA) regulations, including creating an Injury and Illness Prevention Plan, go to the OSHA website (www.osha.gov). For more information on health and safety in the workplace, see The Employer’s Legal Handbook, Chapter 7.
Department of Labor. For information on posters you must display in your business, go to www.dol.gov/elaws/posters.htm. This online “Poster Advisor” feature will help you determine which posters you must display in your workplace. (The Advisor will ask you a series of questions, such as the number of employees and annual dollar volume, and then provide a list of posters you must display and an opportunity to print them.) In addition, you must comply with your state department of labor’s poster requirements. For a list of state departments of labor, go to www.dol.gov/whd/contacts/state_of.htm.
New Hire Reporting Agency. For information on the new hire reporting program, which requires employers to report information on employees for the purpose of locating parents who owe child support, go to the Administration for Children & Families website at www.acf.hhs.gov/programs/css/employers/new-hire-reporting. This website provides a link to state-by-state reporting information. Note that the new hire reporting agency in your state may or may not be your state’s employment department.
U.S. Citizenship and Immigration Services. The U.S. Citizenship and Immigration Services (USCIS) was formerly known as the Immigration and Naturalization Service (INS). You must have each new employee complete USCIS Form I-9, Employment Eligibility Verification, to verify the employee’s eligibility to work in the United States. The form need not be filed with the USCIS, but it must be kept in your files for three years and made available for inspection by officials of the USCIS. This form is included in this book.
Employment Applications. Form 9A: Employment Application requests information on the applicant’s educational background, training, skills, and achievements.
Employee Handbook. If you have more than a few employees, you may want to create a handbook that explains your employment policies. This way, your employees will know what is expected of them and what they can expect from you. Your handbook should include policies on:
pay and benefits
workdays, hours, and time off
discrimination and harassment
complaints and investigations
privacy in the workplace, and
For guidance on the legal and practical considerations as well as electronic versions of policies on each of the above topics, see Create Your Own Employee Handbook: A Legal & Practical Guide for Employers, by Lisa Guerin and Amy DelPo (Nolo).
Form 2B: Partnership Agreement
If you are creating a partnership, you should make a written partnership agreement. A partnership agreement spells out your rights and responsibilities and allows you to structure your relationship with your partners in a way that suits your business. Although the law recognizes partnerships without written agreements, there are huge benefits to putting yours in writing. For one, the process of creating a written agreement forces you and your partners to confront and talk through many important decisions, such as how much money each partner will invest in the business, how profits and losses will be allocated, how the partnership will be managed, and what happens if a partner withdraws from the business. What’s more, a written partnership agreement can provide an invaluable framework to handle later misunderstandings and disagreements, which of course are likely to be part—hopefully a small part—of any business.
Another benefit of creating a formal agreement is that it allows the partners to adjust the operating rules of the partnership to suit their needs instead of being bound by the default rules that state law imposes in the absence of an agreement. For example, suppose you and another partner get into a dispute about the business and one of you sues the other. If you don’t have a written partnership agreement, the judge will decide the case based on your state’s partnership law—which may be different from what you and the other partner would like to happen. By contrast, if you have provided your own way of handling things in a written agreement, it will normally control and determine the judge’s decision.
Example: Al, Barbara, and Carl start a partnership business. Since they’re old friends and don’t like paperwork, they never actually agree on the formula for allocating profits, let alone put it in writing. Because Al will be working full-time in the business and Barbara and Carl will be working only part-time, their joint assumption seems to be that Al will get 50% of the profits and Barbara and Carl will each get 25%. However, a year later, after a bitter falling out among the partners followed by a lawsuit, a judge is forced to consider this issue. Because there’s no written agreement and the oral evidence is inconclusive, the judge must follow state law and rule that each partner is entitled to one-third of the profits.
What Is a Limited Partnership?
The fill-in-the-blanks form in this book is for a general partnership and not a limited partnership—a very different legal animal that combines some attributes of a partnership with some attributes of a corporation.
Most limited partnerships are formed for real estate or other investment ventures where one or more active partners will run a business financed by the investments of a number of silent partners. A limited partnership must have at least one general partner who has the same rights and responsibilities (including unlimited liability) as does a partner in a general partnership. It also must have at least one limited partner (and usually has more), who is typically a passive investor. A limited partner isn’t personally liable for the debts of the partnership—as long as he or she doesn’t participate in managing the business.
Because setting up a limited partnership is complicated, you should see a lawyer if you’re going to start one.
Nolo can help you find the right lawyer. Nolo’s Lawyer Directory offers comprehensive profiles of the lawyers who advertise there, including each attorney’s education, background, areas of expertise, fees, and practice philosophy—including whether the lawyer is willing to review documents or coach clients who are doing their own legal work. Nolo has confirmed that every attorney advertiser has a valid license and is in good standing with the state bar association where the attorney practices. You can find Nolo’s Lawyer Directory at www.nolo.com/lawyers.
Filing Paperwork With State or Local Governments
One advantage of a partnership over a corporation or limited liability company is that you don’t have to file formation documents with a public agency along with a hefty fee. However, in some states, you will need to file a partnership certificate giving the names of the partners. And in a few states, you may also need to publish a notice in the newspaper informing the public that you’ve formed the partnership. Check with the county clerk or the secretary of state’s office for details on your state’s requirements.
For more on partnerships, see Chapter 2 of the Legal Guide for Starting & Running a Small Business, by Fred S. Steingold (Nolo), and Form a Partnership: The Complete Legal Guide, by Denis Clifford and Ralph Warner (Nolo).
Instructions for Form 2B: Partnership Agreement
All the forms in this book are provided in Appendix B and electronically on the Nolo website. To access the eforms online, use the link provided in Appendix A.
Insert the names of all partners.
2. Partnership Name
One of the first things you need to do is settle on a name for your partnership. There are two basic ways to choose your name:
You can combine your own last names, such as “Johnson, Holmes, & Sanchez” as your official partnership name.
You can make up the name under which you’ll do business, such as “Three Guys Contractors,” which is called a fictitious or assumed business name.
Before settling on a partnership name, it’s wise to conduct a name search to avoid a possible conflict with a business that is already using the same name or a similar one. Typically, if your partnership is a small local business, you can feel reasonably secure if you’ve searched for name conflicts at the state and local level. Check the records of the state, county, or local offices where assumed or fictitious business names are filed and the state office where corporations and LLCs are registered. Also check the phone books and city directories covering your area.
If you plan to do business regionally or nationally and will use your business name to identify a product or service, you should consider doing a national trademark search and look into registering your trademark or service mark at both the federal and state levels. For more in-depth information on trademark searches and registration, see Trademark: Legal Care for Your Business & Product Name, by Stephen Elias and Richard Stim (Nolo).
If you decide to use a name that doesn’t include the last names of all of the partners, you’ll need to register your partnership’s name as a fictitious or assumed business name—generally by filing a form at a designated county office. You may also need to publish your partnership name in a local newspaper. Many counties and municipalities have websites that provide more information about registering a fictitious business name and publishing required notices. See www.statelocalgov.net for a comprehensive list of state and local government sites on the Internet.
Insert the name of the partnership.
3. Partnership Duration
Insert the date the partnership began or when it is to begin. Your partnership will begin on whatever date you decide. This can be either a date in the future that you select now, or it can be the same day you sign your partnership agreement.
Next, check one of the boxes to indicate when the partnership will end. Most partnerships last indefinitely—as long as the partners want them to last. However, you can choose a date when your partnership will end. If you are setting up your partnership to complete a specific project, such as developing a particular piece of real estate, you might want the partnership to end on a date that you specify here. If you check the second box, insert a date for the end of the partnership.
4. Partnership Office
Insert the address where partnership records will be kept. Usually this will be the partnership’s main business location. If the partnership’s mailing address is the same as the partnership office, check the first box. If you have a separate mailing address—a post office box, for example—check the second box and fill in the mailing address.
5. Partnership Purpose
Insert the purpose of the partnership. Some examples are:
to operate one or more retail stores for the sale of computer software.
to manufacture and distribute equipment for the preparation of espresso, cappuccino, and other coffee-based beverages.
to design websites for computer users and companies.
to cater banquets, picnics, and other social and business functions requiring food service, and to rent equipment to be used in connection with such catering services.
6. Capital Contributions
Each partner must contribute some property to the partnership in exchange for an ownership interest. The partner can contribute cash, property, or both.
Depending on how readily available the partners’ contributions are, this can be anywhere from a few days to a few weeks or even months after your partnership starts. The important thing to keep in mind is that your business needs to have enough money to operate until the partners make their contributions. In the first blank, enter the date by which the partners will hand over their contributions.
If partners will be contributing cash, fill in their names and the amount each will contribute.
If partners will contribute property, insert the partners’ names. Then describe the property and what value it will be given on the partnership’s books.
Often, partners’ initial contributions are equal, but not always. Unequal contributions are accounted for by granting the partners unequal rights to the partnership’s profits and losses. For example, one partner contributes $6,000 and the other puts in $4,000. Future profits and losses of the partnership are allocated 60% / 40%.
7. Capital Accounts
You don’t need to insert anything here. A capital account is a bookkeeping technique for keeping track of how much of the partnership assets each partner owns. When a partner contributes cash or property to the partnership, the partner’s capital account is credited with the cash amount or fair market value of the property contributed. The partnership will regularly add each partner’s share of partnership profits to the capital accounts. Each partner’s share of any losses and distributions will be deducted. In addition, if the partnership takes out a loan, the capital accounts should reflect each partner’s share of the debt.
See an Expert
Get help setting up your books. If you’re unfamiliar with business bookkeeping, see an accountant to help you get started and to explain how capital accounts work. The accountant can also brief you on how to meet your federal and state business tax obligations. But first, you might want to consult Form a Partnership: The Complete Legal Guide, by Denis Clifford and Ralph Warner (Nolo), which explains the basics.
8. Profits and Losses
You’ll probably want to check the first box. It says that the net profits and losses will be allocated to the partners in the same proportions as their capital contributions. Generally, a partner’s reward for doing work for a partnership is a share of the partnership profits. Checking the first box—having the partners agree to split profits and losses according to their capital contributions—is the easiest and most common method for making such allocations. For example, suppose one partner puts in $20,000 and two other partners put in $10,000 each. The profits will be allocated 50% / 25% / 25%.
If you’d like to split up profits and losses in a way that isn’t proportionate to the partners’ capital contributions, check the second box and insert the percentages to be allocated to each partner. This method is called a special allocation. For example, suppose John and Anna set up a partnership to operate their consulting business. John and Anna put up equal amounts of cash, but they decide that John will be allocated 65% of the partnership’s profits and losses for the first two years, and Anna will be allocated 35% of the partnership’s profits and losses.
If you want to set up a special allocation, you must carefully follow IRS rules, so you’ll need an accountant or tax lawyer to add special language to your partnership agreement to ensure that it will pass muster with the IRS. If the IRS refuses to accept your special allocation, it will deem the profits and losses to be distributed in the same percentage as the partner’s capital contributions.
You don’t need to insert anything here. The assumption behind this section is that partners will be rewarded for their work based on the allocation formula set out in Section 8. Paying salaries to partners creates tax complications for the partnership and the individual partners. You could delete the language in this section, and insert language providing for salaries but, before doing that, seek the advice of a CPA or tax lawyer.
You don’t need to insert anything here. If you would like a partner to receive interest, it’s better to have the person lend money to the partnership. Be sure to document the loan with a promissory note. (See Chapter 4.)
Here you’ll need to decide how partnership decisions will be made—either through the unanimous agreement of all partners, through a majority, or through a combination of the two.
For a small partnership to succeed, the partners need to have both shared goals and confidence in one another’s judgment. If those elements don’t exist, pages of rules as to how decisions should be made won’t help. When it comes to important decisions, it’s smart to talk over the matter with all the partners and respect each other’s opinions. If you agree to require unanimous agreement of all partners, choose the first option.
On the other hand, requiring unanimity on all decisions may be as unnecessary as it is hard to achieve—making it impractical to select the first option. Choosing the second option allows you more flexibility by requiring unanimous agreement on just the major business decisions that you specify, such as renting, buying, or selling real estate, or taking out a business loan.
Let’s briefly look at the potential consequences of each type of decision to help you figure out whether you want to require unanimity for a particular decision.
Borrowing or Lending Money. When the partnership borrows money, each partner in a general partnership is personally responsible for repaying that money if the partnership doesn’t. With such serious consequences, it’s understandable that all partners would want to control the borrowing of money. Similarly, partners should always agree on lending money to outsiders before writing the check.
Signing a Lease. Especially if the partnership is leasing its first commercial space, all of the partners will probably want a say in the location, price, and lease terms. Even if it’s not the first business space, it’s likely that each partner will want to be involved in the decision because each partner is personally liable for the lease payments.
Signing a Contract to Buy or Sell Real Estate. Selling real estate, especially if it is one of the partnership’s main assets, is another matter that the partners will want to agree on. Likewise, buying real estate will probably require a large commitment of the partnership’s capital, so the partners will probably want to unanimously approve that decision as well.
Signing a Security Agreement or Mortgage. Your partnership may have to sign a security agreement or mortgage when taking out a loan. A security agreement or mortgage will place a lien on partnership property; in other words, the partnership property will act as collateral for the loan. If the partnership defaults on the arrangement, usually by failing to make payments on a loan, the lender or creditor can take the property and sell it to pay the debt. Because this can have serious consequences for the business, it’s advisable for partners to agree before pledging property as collateral.
Selling Partnership Assets. If the partnership wants to sell some or all of its assets, all of the partners should discuss the matter and agree. This will help to avoid confusion, arguments, and monetary losses to the business.
Other Decisions. There may be some other decisions for which you want to require unanimity that we haven’t listed here. If that’s the case, describe the action or decision in the space provided.
Releasing any partnership claim, except upon payment in full.
12. Partnership Funds
Insert the name of the financial institution where you’ll keep the partnership funds.
Then check a box to indicate who will be able to sign partnership checks. Many partnerships require the signature of only one partner on business checks, but others require two or more. If you check the last box, insert the number of partners who must sign. In a three-person partnership, for example, you may want to require that checks be signed by two partners.
The financial institution where you have the account will have a form of its own for you to
13. Agreement to End Partnership
You don’t need to insert anything here. This paragraph makes it clear that the partnership can be ended if all the partners agree.
14. Partner’s Withdrawal
Under the laws of most states, if one partner withdraws from the partnership, the partnership will automatically end: The partnership assets will be liquidated, bills will be paid, and the partners will be cashed out. Check the first box if this scenario is what you want.
You can, however, create a different outcome. Check the second box if you want to give the remaining partners the chance to keep the partnership alive by buying out the interest of the withdrawing partner. The partners will have 30 days to decide whether to continue or end the partnership. All remaining partners must agree to continue at that time. Technically, if the remaining partners choose to continue, they will form a new partnership with each other, but the business will continue as if there was no change.
15. Partner’s Death
As with a partner’s withdrawal, a partner’s death will end the partnership—unless you agree to another outcome. Check the first box if you want the partnership assets to be liquidated and the deceased partner’s share of the assets to be paid to that partner’s estate.
Check the second box if you want to give the remaining partners the chance to keep the partnership alive by buying out the interest of the deceased partner. The partners will have 30 days to decide whether to continue or end the partnership. All remaining partners must agree to continue it at that time. Technically, if the remaining partners choose to continue, they will form a new partnership with each other, but the business will continue as if there was no change.
Complete this optional paragraph only if you’ve provided for a buyout of a withdrawing partner’s interest (Paragraph 14) or a deceased partner’s interest (Paragraph 15). If you haven’t provided for a buyout in Paragraph 14 or 15, either cross out this paragraph (in which case, all partners should initial the deletion) or insert the words “Not Applicable” (eform users can just delete it and renumber the paragraphs that follow).
First, insert the number of days the partnership has to pay the withdrawing partner or the deceased partner’s estate for that partner’s interest. Keep in mind that the remaining partners already have 30 days to decide whether they want to purchase the interest and continue the business, so the number of days you select for payment of the buyout price should include this amount of time. For example, if you insert 60 days, the remaining partners will have 30 days to decide whether to buy out the interest and 30 more days to pay for it. The number of days should account for any time the partners will need to determine the value of the partner’s interest, but it should not make the withdrawing partner or the deceased partner’s estate wait too long after the buyout decision is made.
Next you must choose a way to value the interest of a partner being bought out. Here are the alternatives:
Capital Account. A partner’s capital account is the amount of the partner’s contributions, plus any unpaid allocations of profit, less any distributions already made to the partner. It should also reflect the partner’s share of any partnership debts. This is the simplest way to value a partner’s ownership interest: using the dollar value of the partner’s capital account. However, this may not include the value of the business’s assets, its yearly revenues, and profits and intangibles such as goodwill.
Appraisal Value. Another way to value a partner’s ownership interest is to have your partnership’s accountant determine the fair market value of the partner’s interest. This may or may not be appropriate, depending on how knowledgeable the accountant is about your industry and how expensive it would be to have the accountant conduct an appraisal. (Most will charge an hourly or flat fee for this service.)
Using Life Insurance to Fund a Buyout of a Deceased Partner’s Interest
One way to provide the funds to buy out a deceased partner’s interest is to buy life insurance. Although your agreement does not require you to do so, you and your partners can buy life insurance policies on each other in an amount sufficient to pay for the shares of a partner who dies.
If a partner dies, the remaining partners will receive the benefits from the life insurance policy, which they can then use to buy the deceased partner’s interest from the partner’s estate.
While many business owners do not like paying up front for a benefit that may be years away, insurance policies are cheaper than either saving or borrowing money. (You’d have to save much more money than the amount of your insurance premiums to achieve the same payout an insurance policy will give you, and this money wouldn’t be available to help you expand your business.) An insurance policy also guarantees that cash will be available to purchase the shares of a partner who dies unexpectedly.
Other Valuation Methods. There are several other methods of valuing a partner’s interest that use your company’s financial statements from one or more years. These include the book value, multiple of book value, and capitalization of earnings methods. These methods are explained in more detail in Legal Guide for Starting & Running a Small Business, by Fred S. Steingold (Nolo). Depending on your business, one of these methods may be more appropriate than using a partner’s capital account or an accountant’s appraisal.
Check one of the first two boxes if it contains an acceptable formula for fixing the buyout price. If not, check the third box and fill in the method of setting the buyout amount. If you’re not sure which method you want to use, you may want to consult your legal and accounting advisers and talk with other business owners in your field about how they would go about valuing their businesses.
For a more thorough discussion of the subject and a comprehensive agreement with different options, see Business Buyout Agreements: Plan Now for Retirement, Death, Divorce or Owner Disagreements, by Bethany K. Laurence and Anthony Mancuso (Nolo).
Hope you enjoyed this material. The rest of the book is available for purchase.