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August 2024 , 13th Edition
As a small business owner, you can’t afford to farm your routine paperwork and contracts out to a lawyer.
With Legal Forms for Starting & Running a Small Business, you can handle a wide range of business forms and agreements on your own.
Here you’ll find the forms you need to start and grow your business. Each document comes with thorough, plain-English, line-by-line instructions to help you:
The 13th edition has been thoroughly reviewed and updated by Nolo’s experts and provides the most up-to-date legal information for small businesses.
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9781413331943 Number of Pages Included FormsThese forms are accessible online. After purchase, you’ll find the link in Appendix A.
Nolo’s editorial department includes more than a dozen legal editors and a full-time legal researcher, who collectively have more than 100 years’ experience turning legal jargon into plain English. Most of our editors gave up careers as practicing lawyers in favor of furthering Nolo’s mission: Getting legal information into the hands of the people who really need it. All Nolo legal editors specialize in certain areas of the law, and many are recognized as national experts in their field. They write books, edit books by outside authors, and in their spare time write online articles and blogs, develop legal forms, and create the legal content of Nolo software.
When you start a new business, you must choose a legal structure. For most small businesses, the choices come down to these:
Other legal structures—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 an 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:
TIP
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 against lawsuits. This means that there might not be a compelling need to form a corporation or an LLC when you’re just starting out.
With Nolo’s online formation service, 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 formation now, go to www.nolo. com/products/business-suite/business-formation/ online-business-formation-services.
RESOURCE
For in-depth information on choosing a legal structure for your business, and for additional information on many of the topics in this chapter, see Legal Guide for Starting & Running a Small Business, by Stephen Fishman (Nolo). You can also get lots of useful information in the Business Formation section of Nolo.com.
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’re 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 might arise later. 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.
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 their 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 their ownership interest in the corporation.
This checklist makes a great to-do list for starting your business.
The checklist and all of the forms in this book are provided in Appendix B and on the Nolo website. To download the checklist and forms online, use the link provided in Appendix A. This next section describes each task listed in the Checklist for Starting a Small Business.
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.
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.
To learn about writing a business plan and marketing your business, see The Small Business Start-Up Kit: A Step-by-Step Legal Guide, by Peri Pakroo (Nolo).
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 bring liability risks not covered by insurance.
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 do 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 might need to do a more sophisticated federal trademark search.
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. (An example of an assumed name/fictitious name filing is below.)
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.
SKIP AHEAD
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 Stephen Fishman (Nolo), Chapter 2.
Limited liability companies. To form an LLC, owners must file articles of organization (or in some states, a “certificate of organization” or “certificate of formation”) and sign an operating agreement. An operating agreement helps ensure your personal liability protection by showing that you have been conscientious about organizing your LLC. For more information on forming an LLC, see Legal Guide for Starting & Running a Small Business, by Stephen Fishman (Nolo), Chapter 4.
If your LLC will have multiple owners, you can create an operating agreement on Nolo’s website (www.nolo.com).
Corporations. To form a corporation, incorporators must file articles of incorporation (in some states they’re called certificates of incorporation, articles of association, or charters). In most states, the secretary of state can give you a printed form for this essential document—or you can find the form online; all you have to do is fill in some blank spaces. Although details vary from state to state, you’ll typically need to include:
You’ll file the form with the secretary of state (or other designated official) and pay an incorporation fee. Your corporation will also need to adopt bylaws. When you’re ready, use Form 2C: Preincorporation Agreement, Form 2D: Corporate Bylaws, and Form 2E: Stock Agreement.
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.
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 Stephen Fishman (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, check out Nolo’s articles on commercial leases on Nolo.com (on the home page, type “commercial lease” in the search box).
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 the Nolo articles referenced just above. To create your own lease, see Chapter 5 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 Stephen Fishman (Nolo), Chapter 14.
You will need to complete general business registration requirements. You might need to obtain a business license from your municipality or state, an employer identification 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’re forming a partnership or corporation or your business will hire employees, you need to obtain a taxpayer ID from the IRS. You can do this online on the IRS website or by filing 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 might 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 can 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 might 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. You might 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, each 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 in case 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 their 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 might be appropriate. There’s no substitute for establishing a good working relationship with a knowledgeable insurance agent or broker.
Before the end of your first year, you’ll need to learn how to report your income, which can 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 begin to incur start-up costs.
How your business is taxed. For a complete guide to small business taxation, see Tax Savvy for Small Business, by Stephen Fishman (Nolo).
Deductions and depreciation. Just about any necessary and reasonable expense that helps you earn business income is deductible. For information on deducting expenses, see Deduct It! Lower Your Small Business Taxes, by Stephen Fishman (Nolo).
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:
Chances are you will 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 Aaron Hotfelder (Nolo), provides excellent information on wage and hour laws, anti-discrimination statutes, and leave policies. You’ll find additional help in “Hiring Your First Employee: 13 Things You Must Do,” a free article on Nolo’s website. 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 8F: 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 payroll 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 and mail or fax it 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 https://statelocal.co.
You’ll also need to file IRS Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, to report your federal unemployment tax. You must file this form for any year in which you:
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, Employee’s Withholding Allowance Certificate, 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 their 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/free-resources/insurance-industry-links/workers-comp-agencies.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:
Employment applications. Form 8A: 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 might 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:
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 Sachi Clements (Nolo).
Partners in a general partnership, and general partners in a limited partnership, don’t have limited liability for business debts. In other words, creditors of the business can go after their personal assets to satisfy business debts. For that reason, before you create a partnership agreement for your partnership, consider the risks associated with the business and whether you and your partners want to have the limited liability protections of a multi-member LLC. The partnership structure is appropriate for businesses with little risk of incurring debts that it can’t pay, and perhaps that involve short-term ventures rather than long-term operations.
If you decide to operate your business as 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 among the partners, 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 misunderstandings and disagreements, which of course are likely to be part—hopefully a small part—of any business.
Form 10B 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 that partner 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.
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 might 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.
| 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 might 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. |
RESOURCE
For more on partnerships, see Chapter 2 of the Legal Guide for Starting & Running a Small Business, by Stephen Fishman (Nolo).
All the forms in this book are provided in Appendix B and on the Nolo website. To access the downloadable forms online, use the link provided in Appendix A.
Insert the names of all partners.
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:
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 Fishman (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 or state office. You might 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 https://state-local.co for a comprehensive list of state and local government sites on the internet.
Insert the name of the partnership.
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.
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.
Insert the purpose of the partnership. Some examples are:
Each partner must contribute something 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, the contribution deadline 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.
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%.
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.
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 might need 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 could 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.
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 might 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 fill out.
You don’t need to insert anything here. This paragraph makes it clear that the partnership can be ended if all the partners agree.
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.
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.” (If you’re using the downloadable form, 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 might 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 might or might 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.)
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 Stephen Fishman (Nolo). Depending on your business, one of these methods could 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 might 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.
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 could 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.
The remainder of the agreement contains the standard clauses we discussed in Chapter 1. The only thing you’ll need to fill in here is the name of the state whose law will apply to the contract in the paragraph called “Governing Law.”
Fill in the date the agreement is signed. Each partner must sign their name, and their respective names and addresses should be typed in.
We hope you enjoyed this sample. The complete book is available for sale here at Nolo.com.
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9781413331943 Number of Pages Included FormsThese forms are accessible online. After purchase, you’ll find the link in Appendix A.
