While investment clubs provide an opportunity for friends or family to learn about investments and make money, it's best to treat an investment club as you would any other business relationship.
An investment club consists of individuals who combine their money to invest for the mutual advantage of the members of the group. Whether they are informal groups or launched as a business entity such as a partnership, investment clubs should consider regulatory oversight and must properly account for taxes.
Here are some important aspects to consider when forming an investment club:
Written agreements. Most investment clubs are formed as partnerships. Every partnership should consider adopting a written partnership agreement. This legal contract outlines how the business will operate and how profits and losses will be allocated among the partners. In the beginning, your investment may seem small, and it's easy to dismiss the need for this document. However, a successful investment club can accumulate substantial assets. Having this document in place from the beginning can prevent problems later, such as how to liquidate a partner's interest when one leaves.
Taxes. Even though partnerships don't pay income tax, they must still file an annual return with the IRS to report gains and losses. Partnerships must also provide Form K-1 to each partner to report each partner's share of income and deductions that is being passed through to them. Each partner must then include the K-1 on their individual income tax return. If the partnership fails to file a return, the IRS can assess late filing penalties.
Member duties. As in any business, it's a good idea for club members to share financial duties. Consider requiring two signatures to transfer funds between accounts. Periodically review the treasurer's records to make sure that transactions were properly authorized by the club, that the record-keeping is adequate, that tax returns were filed, and that all money and stocks are properly accounted for.
An investment club with sound business practices has a much better chance of a long and successful existence. If you're considering launching an investment club, contact us for advice on the best course of action.