Want to Start An Investment Club – Organization and Accounts

This post is the second in a three-part series discussing Investment Clubs, their formation, and operational realities. If you missed part one which discussed starting an investment club and picking the right group, check it out here.

As expected with a post like this, none of the below should be construed as legal or financial advice. Please consult your own legal and financial advisors before investing or starting an investment club. Be sure to come back next week as I discuss making investment decisions as a group and the rewards of being a member of an investment club.

Investment Club Organization and Administration

Once you’ve decided upon a group on individuals for your investment club, you will need to organize from a legal and administrative standpoint. This is fortunately not too complicated given the wealth of information online. The basic steps are forming the investment club’s legal entity, drafting and approving an operating or partnership agreement, and registering with both your Federal and State authorities.

Legal Entity: There are several types of legal entities, all with their own pros and cons. In looking for an ideal entity, you are looking for something that will be both cost-effective and flexible. As such, for my club, we determined that a general partnership would be the most practical entity for us. General partnerships provide for the ultimate flexibility without the higher costs associated with the various types of corporations. For my investment club, in our state of domicile, it would not have been cost-effective to pay the annual registration fees and sacrificing ease of filing and managing any change in members.

One downside to general partnerships is the lack of true entity liability protection. However, we decided that since we would not be investing on margin, taking on any other debt, secured or unsecured, we had no need for the additionally liability protection a LLC or full-blown corporation might have been able to provide. As a general partnership, each owner will receive an IRS Schedule K-1, otherwise known as a partner’s share of income, once a year to report upon and file with their personal returns. Be sure to check with your legal advisor as to what entity would be best for your investment club.

Operating/Partnership Agreement: Once you have decided on an entity, it is then up to the club to draft and endorse an operating agreement or partnership agreement. While there are plenty of online samples or guides to this, I would recommend all legal documents get reviewed by your attorney. This documentation will serve as the road map to all investment decisions, addition and subtraction of club members, and any other rules as decided upon by the members.

In setting up an investment club, you will want to spend a lot of time determining your roles and responsibilities as members. With a larger investment club, determining who has the fiduciary responsibility for all financial transactions is important. With “too many hands in the kitchen,” keeping track of transactions and maintain the financial records of the club might become challenging. Make these logistic designations and include them with your signed agreement.

As an aside: implicit in forming an investment club is a level of trust and financial responsibility. You will be giving access to others to trade, manipulate, and invest your money. Protect yourself and your interests by developing a legal framework to support that trust.

Register your Investment Club: After completing the previous two steps, the final step in setting up your investment club will be to register with your state of domicile and the federal reporting authorities. This is a fairly simple process for the federal portion. All you will need to do is submit an SS-4 to apply for an Employer Identification Number (EIN), which can be done quickly online at the IRS’s website. Unfortunately, each state has different filing requirements, so checking with your states’ Department of Taxation/Revenue. I would recommend you talk to your accountant or attorney to determine the best means of registering with your particular state as there can be penalties for not completing this correctly.

Investment Club Financial Accounts

Once your investment club has been set up legally, the procedures and polices documented in an organizational document, and lastly, registered with the appropriate authorities, you can open checking and brokerage accounts. Most clubs will need both accounts as many discount brokers will not allow you to directly link your club’s account with your personal checking accounts. Because of this, you will need to have an account that allows electronic transfers from personal accounts, of course assuming you allow electronic deposits.

For convenience, I found it incredible beneficial to have the club’s checking account to be at a bank in which I had physical access. While this is not necessary, they can help walk you through the process of setting everything up, designating signatures on the account, and answer any other questions you might have.

Pretty much every discount brokerage company out there allows investment clubs to open an account. However, the costs can be significantly different. We originally started our club’s account at TradeKing, but because of a new fee structure put into place a couple of years after opening, we switched our accounts to Schwab.

As with any form of investment account, finding the “sweet” spot where your transaction and account costs are minimized and the level of customer service is high will be where you want to sign up for an account. Not all brokerage firms are the same. Be sure to read the detailed fee structure provided by your broker to determine the various fees that might affect your account above and beyond actual transaction costs.

With part two in the bag, I hope you are discovering that starting an investment club isn’t as daunting as you might think! If you have any questions, please contact me, or ask in the comments below! Come back next week for the final part of the series!

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