All of us know, or should know, that we need to save and safeguard our business records. When we start up it’s easy to hang on to every document, receipt, invoice, and business record. But after a few years we find that all these records we’ve been keeping are taking up more floor space in file cabinets than the work spaces for ourselves and our employees.

The good news is that we really don’t have to keep all those records forever. Yes, some we do need to keep forever. Some we keep only until the IRS has had their way with us. And some we need to keep for only a few years.

Determining which records need to be kept, and for how long, is a little harder. And properly disposing of temporary records is not as simple as just tossing the papers into the recycling bin.

Here is where the Records Retention Schedule comes into play. This document lists the types of records your business produces (financial, personnel, employee handbooks, contracts, operations, meeting minutes, policy statements, online privacy statements … the list can seem endless); identifies any legal requirements for how long the record must be kept and the requiring authority, such as the IRS or the Sarbanes-Oxley Act; will note how long the record is generally actively used in business operations; and may contain other information as well, such as noting that the records contain sensitive personal identifying data; and if microfilm or digitally scanned copies are acceptable legal alternatives to the paper document.

Search the Internet and you will find plenty of information about Records Retention Schedules and samples, such as this one kindly offered by Millennium Records Management. Remember, however, that a sample schedule is just a generalized representation of what one looks like. Your Records Retention Schedule will be tailored to your type of business, where you are located, in what state(s) and/or countries you do business, whether you are privately owned or trade shares on the stock market, are a public institution, hold government contracts, and a myriad other factors.

You will want to work with your accountant, legal counsel, and/or a professional records management company to develop and establish yours.

You implement the Records Retention Schedule officially so everyone in your company knows about it. This helps ensure that your vital records are actually kept in the first place. Later, say you have several file cabinets of Accounts Payable invoices. Your Retention Schedule says you need to keep these for 6 years, but experience shows you really only get into them for 3 years. Knowing this, you can free up your business/office floor space by transferring these records to secure off-site storage or an acceptable alternative storage media.

Once you have records that reach the end of their retention period you can dispose of them. But, as I said, you can’t simply toss them into the recycling can. You need to have an established process for their disposal. Yes, you have to create more documentation to get rid of old documents.

You will want to have the people who generated the records sign off that they no longer need the records. You should note that the records have reached the end of their retention period according to your established Records Retention Schedule, and check that their retention period has not been extended due to audits, litigation, etc.

You will want to certify when, how, and by whom, the documents were destroyed. This is easier today, than in the past, when I spent many hours hauling boxes down to a loading dock and feeding paper into a shredder next to a dumpster. In recent years mobile shredding companies have proliferated. They will drive their big truck-mounted confetti shredders to your business, haul your boxes to the truck, let you witness their destruction and give you a certificate of destruction.

Establishing, implementing, and following a Records Retention Schedule will go a long way to ensuring that your company keeps and maintains the vital records you need to continue in business. And, in a worst case scenario, should you be caught up in litigation or the like, prove that your records are kept and destroyed in a regularly occurring, established, approved, documented process, and not in a midnight burn out behind the barn in an amateurish attempt to avoid culpability and responsibility, or obstruct the legal process.

All sorts of groups, from artists and musicians to people active in education, health, and community services wish to operate as nonprofit (or not-for-profit) corporations. Often the reason for doing this is simple — nonprofit status is usually a requirement for obtaining funds from government agencies and private foundations. Obtaining grants, however, is not the only reason to incorporate. Here, we discuss two additional important benefits of forming a nonprofit — tax-exempt status and personal liability protection. We then introduce you to some of the basic rules for setting up and running your nonprofit corporation.

Tax-Exempt Status
In addition to qualifying for public and private grant money, most nonprofit groups seek nonprofit corporate status to obtain exemptions from federal and state income taxes. The most common federal tax exemption for nonprofits comes from Section 501(c)(3) of the Internal Revenue Code, which is why nonprofits are sometimes called 501(c)(3) corporations. (To learn about applying for tax exemptions, read How to Form a Nonprofit Corporation.)

If your group obtains tax-exempt status, not only is it free from paying taxes on all income from activities related to its nonprofit purpose, but people and organizations that donate to the nonprofit can take a tax deduction for their contributions. For more information on which activities are considered related to a nonprofit’s purpose, see Earning Income as a Nonprofit Corporation.

Protection From Personal Liability
Forming a nonprofit corporation normally protects the directors, officers and members of the nonprofit from personal liability for the corporation’s debts and other obligations. Called “limited liability,” this shield ensures that anyone who obtains a judgment against the nonprofit can reach only the assets of the corporation, not the bank accounts, houses or other property owned by the individuals who manage, work for or participate in the business.

As an example, consider a nonprofit symphony that is sued by a visitor who falls through a poorly maintained railing on a staircase. The court finds in favor of the visitor and issues a judgment against the nonprofit for an amount greater than the nonprofit’s insurance coverage. The amount of the judgment is a debt of the corporation, but the directors, officers and members are not personally responsible for paying it. By contrast, if an unincorporated association of musicians owned the premises, the principals of the unincorporated group could be required to pay the judgment amount out of their own pockets.

Exceptions to the Limited Liability Rule
In a few situations, people involved with a nonprofit corporation can be held personally liable for its debts. A director or officer of a nonprofit corporation can be held personally liable if she:

• personally and directly injures someone
• personally guarantees a bank loan or a business debt on which the corporation defaults
• fails to deposit taxes or file any necessary tax returns
• does something intentionally fraudulent, illegal or clearly wrong-headed that causes harm, or
• co-mingles nonprofit and personal funds.

To cover some of these exceptions, reasonably priced insurance is available to protect volunteer directors, who may be reluctant to serve without it.

Additional Benefits for Your Nonprofit Corporation
Tax-exempt grants and personal liability protection are the most important reasons to incorporate your nonprofit group, but there are still more benefits to be had. To learn about them, read Five Reasons to Incorporate Your Nonprofit Association.

Who Should Consider Becoming a Nonprofit
The types of groups that typically seek nonprofit status vary widely. Here’s a partial list of associations that may be eligible:

• child care centers
• shelters for the homeless
• community healthcare clinics
• museums
• hospitals
• churches, synagogues, mosques and other places of worship
• schools
• performing arts groups, and
• conservation groups.

If your group isn’t on this list, it doesn’t necessarily mean you won’t qualify for tax-exempt status. As long as your group’s activity is charitable, educational, literary, religious or scientific, you should be able to get a tax exemption.

Forming a Nonprofit Corporation
Forming a nonprofit corporation is very similar to forming a regular corporation: You must file “articles of incorporation” with the corporations division (usually part of the Secretary of State’s office) of your state government. But unlike regular corporations, you must also complete federal and state applications for tax exemptions.

After filing this initial paperwork, you will create “corporate bylaws,” which lay out the operating rules for your nonprofit. Finally, you elect the initial directors of your nonprofit and hold an organizational meeting of the board. (To learn more about forming a nonprofit corporation, see How to Form a Nonprofit Corporation

Running a Nonprofit Corporation
Most nonprofit corporations are run by a board of directors — called “trustees” in some states. The directors set policy for the nonprofit and are usually actively involved in the work of the corporation. Officers (who may also serve on the board) carry out the day-to-day business of the corporation and sometimes receive salaries. Depending on its structure, a nonprofit may or may not have formal members with voting rights. If the nonprofit does not create a formal membership structure, the only people who participate in the management of the nonprofit are the directors and officers.

Nonprofit corporations must observe most of the same formalities as regular corporations. These include keeping good corporate records, holding and preparing minutes of directors’ (and possibly members’) meetings and maintaining a separate bank account.

Unlike regular corporations, a nonprofit corporation cannot distribute any profits to its members, contribute money to political campaigns or engage in lobbying activity, except in very limited circumstances. (For more information about recordkeeping and further details about what nonprofits can and cannot do, see Running Your Nonprofit Corporation.)

Ending a Nonprofit Corporation
Nonprofits are not actually owned by anyone and therefore cannot be sold. If the directors of a nonprofit corporation decide to dissolve it, they must pay off all debts and obligations of the nonprofit and distribute all of its assets to another tax-exempt nonprofit corporation.

So you are starting a new business and you and your partners are really excited about the endless possibilities that await you. The last thing you want to think about is the worst-case scenario — the failure of the business or a partnership gone wrong.

Failure to plan and lack of funding are both leading contributors to small business failure in the U.S. If you are planning to go into business with a partner, then it is critical that you set up a partnership agreement. This is easy to do, but often overlooked during the business planning process. Without an agreed-upon strategy on how you will handle certain unforeseen events, how will you know how your partners will react? If you have a disagreement, will they be willing to exit the business and sell you their shares? These are important questions to address in the early stages of planning your business. It is easiest to come to a consensus when all the partners have the same interest in mind—building a successful business.

Once the business begins to operate, the partners’ personal interests may vary considerably, so it is vital to negotiate all of the terms while you all have similar objectives. This could prevent major issues from arising further down the road, and it allows everyone to clearly understand and sign off on the “rules” moving forward. This important step is not only for start-ups. If you have an existing business that is a partnership without a partnership agreement, you need to get one in place as soon as you are done reading this!

Let’s say you own a small company with one partner and you are both employees with equal ownership of the company. For argument’s sake, let’s say you have been operating without a formal partnership agreement for a year and a half and the money is really starting to roll in. Suddenly, without prior notice, your partner has a life-changing event. This might include personal bankruptcy, divorce, or even worse, a sudden death. Do you know what effect this will have on your business? Who will own your partner’s shares? Do you have the right to buy those shares in any of these cases?

Without an agreement up front, these questions cannot be answered easily and you run the risk of having some unanticipated new partners. Imagine your partner getting a divorce and now having to deal with the ex-spouse as an equal partner. Think of a partnership agreement as a “prenuptial” agreement between you and your business partners. You don’t expect to have the partnership break up, but you just never know what could happen down the road.

So what does a partnership agreement look like? It can be as simple as stating the terms in which one partner would buy out the other, sometimes referred as a “Buy-Sell” agreement. It should clearly state what occurs in the event that one partner needs to exit the business for any number of reasons. The best way to generate a partnership agreement between you and your partners is to consult an attorney and have the agreement created with your specific requirements. If you would prefer to save a little money, there are other options available, from legal business software to standard legal forms available from your stationery store. Whichever method you choose, just make sure you have one in place. You can always go back and revise it, but without one, you might be working those 80-hour work weeks for nothing!

An important component of the partnership (or buy-sell agreement) is the valuation portion of the contract. If you need to execute the agreement, how are the shares going to be valued? This can quickly turn a simple agreement into a very complex document, and is something that needs to be considered carefully in the early stages. Not only does this need to be established during the early planning stages, but it should also be reviewed on an annual basis. The simplest form of valuation to use is a multiple of total revenue. For many small businesses, this is the best option to use when setting up your initial agreement. Not only is it easier to agree upon a fair calculation, but there is less room for subjective or questionable amounts to be produced.

For example; if at the end of the first year your business had gross sales of $500,000 and you agreed that you would use a multiple of two for valuation purposes, then the company has a stated value of $1 million. This may not have anything to do with the true market value of the business, but it should, as closely as possible, match your best estimate of the market value for your business. As the company grows and additional shareholders become involved, you may want to consider a different approach to the valuation within your agreement. As long as all partners agree, this can be changed at any time. If fundamental changes occur in your business, you can always update this valuation to reflect the current situation. This is especially important when experiencing fast growth or bringing on additional partners.

As your business becomes more complex, so may your valuation terms. You may prefer to create a formula that uses a multiple of earnings to value the business. The stock market is a prime example of this type of valuation, also referred to as “market value.” You will often see a reference to the PE (Price to Earnings) ratio when looking at the price for publicly-traded stocks. This is no different from creating your own PE ratio to value the business. You are simply stating the exact formula to use, since an open market for your shares does not exist within a privately-held company.

There is no right or wrong way to value the business in a partnership agreement. It just needs to be clear so it cannot be questioned, should you need to use it in the future. Ideally, it should include an easy-to-understand formula or calculation on which all the partners agree. As mentioned above, this can be as simple as a multiple of revenues, multiple of earnings, multiple of actual book value or net worth, or anything else that can have a value associated with it.

Many partnership agreements include a clause stating that when they need to value the shares of the business, a CPA will be retained to place a real market value on the business. Although this will most likely result in a true market value for the business at that point in time (since it considers market competition, minority shareholder discounts, and many other market factors), it is still subject to challenge. Depending upon the nature of the situation for enacting the agreement, this could also create an increase in professional fees paid out, particularly if one partner does not agree with the calculated valuation. Although this is a widely accepted way to value the business in a partnership agreement, it is not always the best option, particularly for smaller partnerships and businesses.

Determining the valuation for the business within a partnership agreement is meant to protect the business from an unexpected change in ownership. Since this is an internal document, it does not have any impact on the valuation of the business outside of the partnership, should you and your partners want to sell the business to a third party. The true value of any business is simply the amount someone is willing to pay for it.

Many, if not most, LLC owners overlook a critical element of their operating agreement that can save them both money and angst: buy-sell provisions. When you create buy-sell, or buyout, provisions for your operating agreement, you and your co-owners can prepare for events that have been the downfall of more than a few successful small businesses — namely, the death, divorce, bankruptcy or retirement of one of the owners.

What is a buy-sell agreement?
Contrary to popular belief, a buy-sell agreement is not about buying and selling companies; rather, it is a binding contract between business owners. A buy-sell agreement is made up of several clauses in your written operating agreement (or it can be a separate agreement that stands on its own) that control the following business decisions:

• who can buy a departing member’s share of the business (this may include outsiders or be limited to other LLC members)
• what events will trigger a buyout (see the list below), and
• what price will be paid for a member’s interest in the LLC

It may help to think of a buy-sell agreement as a sort of “premarital agreement” between you and your co-owners.

What events should you cover under a buy-sell agreement?
Your buy-sell agreement will instruct and remind you and your co-owners how you have agreed to handle the sale or buyback of an ownership interest when one member’s circumstances change. Typically, the events that trigger a buyout of a member’s interest under a buy-sell agreement are:

• an attractive offer from an outsider to purchase a member’s interest in the company
• a divorce settlement in which a member’s ex-spouse stands to receive an ownership interest in the company
• the foreclosure of a debt secured by an ownership interest
• the personal bankruptcy of a member, or
• the disability, death or incapacity of a member.

Why you need buy-sell provisions
It’s a huge mistake to ignore the fact that sooner or later your business will change. If you doubt this even for a minute, think about what would happen if you don’t create a buy-sell agreement and one of the following occurs:

• One member quits to move to another city or leaves to start another business. Without an agreement, your LLC might be automatically dissolved, forcing you to divide any assets and profits among the LLC members and decide whether to start a new LLC with the remaining LLC members. If your LLC doesn’t end, you must still decide whether you should buy out the departing LLC member’s ownership interest, and for how much.
• One member dies, gets divorced or becomes mentally or physically incapacitated. In this case, you might have to work with the spouse or other family member of a deceased, disabled or divorced owner. There is a substantial possibility that the family member would be inexperienced or otherwise unable to act in the best interests of the business. On the flip side, you (or your family) might get stuck with a small business interest that no outsider wants to buy and for which no insider will give you a decent price.
• One member sells his or her share to a stranger or to someone you know well and can’t stand. In this case, you may be forced to share control of the company with an inexperienced or untrustworthy stranger — or you’ll be faced with the struggle of running a business with someone you’d rather not even see on the street.

Just looking at this list, it should be obvious that if you don’t anticipate and plan for circumstances like these, you’re risking serious personal and business discord — perhaps even court battles and the loss of your business.

Creating a buy-sell agreement
To create buy-sell provisions, you can use either a self-help resource or see a lawyer — or both. One good tool is Nolo’s Business Buyout Agreements: A Step-by-Step Guide for Co-Owners, by attorneys Anthony Mancuso and Bethany K. Laurence, which contains a disk with fill-in-the-blank buyout clauses and instructions on how to incorporate them into your operating agreement. Even for those who want the services of a lawyer, this book walks you through the necessary discussions with your co-owners, so you can decide on your own time — not your lawyer’s — which terms you want to include.

Copyright © Nolo

An LLC operating agreement allows you to structure your financial and working relationships with your co-owners in a way that suits your business. In your operating agreement, you and your co-owners establish each owner’s percentage of ownership in the LLC, his or her share of profits (or losses) and his or her rights and responsibilities, as well as what will happen to the business if one of you leaves.

Why an operating agreement is necessary
While many states do not legally require your LLC to have an operating agreement, it’s foolish to run an LLC without one, even if you’re the sole owner of your company. An operating agreement helps your LLC by guarding your limited liability status, heading off financial and management misunderstandings, and making sure your business is governed by your own rules — not the default rules of your state.

Protecting your limited liability status
The main reason to make an operating agreement is as simple as it is important: It helps to ensure that courts will respect your limited personal liability. This is particularly key in a one-person LLC, where, without the formality of an agreement, the LLC will look a lot like a sole proprietorship. Just the fact that you have a formal written operating agreement will lend credibility to your LLC’s separate existence.

Defining financial and management structure
Co-owned LLCs need to document their profit-sharing and decision-making protocols as well as the procedures for handling the departure and addition of members. Without a thorough operating agreement, not only will you and your co-owners be ill-equipped to settle misunderstandings over finances and management, but you will also be subject to the rules of your state law (see below).

Overriding state default rules
Each state has laws that set out basic operating rules for LLCs, some of which will govern your business unless your operating agreement says otherwise (these are called “default rules”). Many states, for example, have a default rule that requires owners to divide up LLC profits and losses equally, regardless of each member’s investment in the business. Unless you and your co-owners invest equal amounts in the LLC, it’s doubtful you’ll want profits allocated this way. To avoid this, your operating agreement must spell out how you and your co-owners want to split profits and losses.

In this same way, many state laws regarding LLCs will not be favorable to your business. Don’t be tempted to rely on them to structure your LLC; instead, decide on the best rules for your situation and put them in a written operating agreement.

What to include in your operating agreement
There’s a host of issues you must cover in your operating agreement, some of which will depend on your business’s particular situation and needs. Most operating agreements include the following:

• the members’ percentage interests in the LLC
• the members’ rights and responsibilities
• the members’ voting power
• how profits and losses will be allocated
• how the LLC will be managed
• rules for holding meetings and taking votes, and
• “buy-sell” provisions, which establish a framework for what happens when a member wants to sell his interest, dies or becomes disabled.

While these items may seem fairly straightforward, each is rife with details. Make sure you fill out the particulars in the following key areas.

Percentages of ownership
The owners of an LLC ordinarily make financial contributions of cash, property or services to the business to get it started. In return, each LLC member gets a percentage of ownership in the assets of the LLC. Each member is usually given an ownership percentage that’s in proportion to his contribution of capital, but LLCs are free to divide up ownership in any way they wish. These contributions and percentage interests are an important part of your operating agreement.

Distributive shares
In addition to receiving an ownership interest in exchange for his investment of capital, each LLC owner also receives a share of its profits and losses, called a “distributive share.” Most often, an operating agreement will provide that each owner’s distributive share corresponds to his percentage of ownership in the LLC. For example, because Tony owns only 35% of his LLC, he receives just 35% of its profits and losses. Najate, on the other hand, is entitled to 65% of the LLC’s profits and losses since she owns 65% of the business. (If your LLC wants to assign distributive shares that aren’t in proportion to the owners’ percentage interests in the LLC, you’ll have to follow rules for “special allocations.”)

Distributions of profits and losses
In addition to defining each owner’s distributive share, your operating agreement should answer these questions:

• How much — if any — of the allocated profits of the LLC (the members’ distributive shares) must be distributed to LLC members each year?
• Can members expect their LLC to pay them at least enough to cover the income taxes they’ll owe on each year’s allocation of LLC profits?
• When will distributions of profits be made?
• Or are the owners entitled to draw periodically from the profits of the business?

Because you and your co-owners may have different financial needs and marginal tax rates (tax brackets), the allocation of profits and losses is an area to which you should pay particular attention.

Voting rights
While most LLC management decisions are made informally, sometimes a decision is so important or controversial that a formal vote is necessary. There are two ways to split voting power among LLC members: either each member’s voting power corresponds to her percentage interest in the business or each member gets one vote — called “per capita” voting. Most LLCs mete out votes in proportion to the members’ ownership interests. Whichever method you choose, make sure your operating agreement specifies how much voting power each member has as well as whether a majority of the votes or a unanimous decision will be required to resolve an issue.

Ownership transitions
Many new business owners neglect to think about what will happen if one owner retires, dies or decides to sell his interest in the company. These concerns may not be on your mind now, but such situations crop up frequently for small business owners, and it pays to be prepared. Operating agreements should include a buyout scheme — rules for what will happen when one member leaves the LLC for any reason. For more information, see Plan for changes in LLC ownership with buy-sell provisions.

How to create an operating agreement
Obviously, you’ll need help beyond this article to make your own operating agreement. There are many sources for blank or sample LLC operating agreements, but you must be sure that your operating agreement is drafted to suit the needs of your business and the laws of your state.

Law libraries are a good source of state LLC law as well as technical material on preparing an operating agreement, but since the material is written for lawyers, you may find it more confusing than helpful.

You can pay a business lawyer for assistance, and in fact we recommend this for LLCs with more than five owners, or for those that opt to have a special manager or management group run the LLC. Lawyers typically have several types of standard agreements on hand that can be customized for your LLC.

If expense is an issue, software that helps you create your own LLC may be your best alternative. For example, LLC Maker (from Nolo.com) will use your input to customize an operating agreement that suits the needs of you and your co-owners and meets the requirements of your state’s laws.

Copyright © Nolo

Nonprofit corporations are organized very much like regular corporations; however, running a nonprofit corporation means complying with a few special rules. Here’s what you need to know.

Organizational structure of nonprofit corporations
Like any corporation, a nonprofit has a board of directors to make important policy decisions, officers (president, treasurer and secretary) to oversee and manage the day-to-day operations of the organization, and possibly employees to do the work.

Unlike regular corporations, however, nonprofit corporations do not have shareholders or owners. (Nonprofits are owned by no one person or group of persons and cannot be sold. In the event the directors of a nonprofit want to dissolve the corporation, they must distribute all of its assets to another nonprofit corporation.)

Although a nonprofit corporation can choose to have members who have voting rights, many nonprofit corporations decide not to adopt a membership structure and, in the interests of efficiency, leave the decision making up to the directors. If a nonprofit does opt for a membership structure, the members participate in major corporate decisions. Specifically, the members have the exclusive right to elect directors, amend articles and bylaws and vote on a merger or dissolution of the corporation.

Corporate records
All nonprofit corporations must keep good corporate records. These records help to preserve directors’ limited personal liability and protect your organization’s tax-exempt status. Good recordkeeping means preparing minutes of directors’ and members’ meetings and documenting important corporate decisions.

You’ll want to organize these materials in a corporate records book, which should also contain a copy of your articles of incorporation, bylaws and tax exemption determination letters from the IRS and your state tax agency, if applicable.

Keeping financial records
In addition to keeping records of important decisions, your nonprofit corporation must record any financial transactions in a double-entry bookkeeping system and keep other financial records in order to file an annual corporate tax return. For more, see Earning income as a nonprofit corporation.

Limits on nonprofit activities
In addition to keeping corporate records, nonprofit corporations must follow some additional rules and abide by certain prohibitions in order to retain their tax-exempt status:

• Nonprofit corporations cannot contribute money to political campaigns. Nonprofit corporations with a 501(c)(3) tax exemption (the most common) are not allowed to participate in political campaigns or contribute money to them. If they do, the IRS can revoke their nonprofit status, and can assess a special excise tax against the organization and its managers.
• Nonprofit corporations can engage in only limited lobbying activities. Tax-exempt 501(c)(3) nonprofits that influence legislation to any “substantial degree” face the loss of their nonprofit status. However, for tax-exempt nonprofits that want to participate in lobbying, the IRS simply sets a limit on the money they can spend on political activities.
• Nonprofit corporations must not distribute profits to members, officers or directors. A nonprofit corporation cannot be organized to financially benefit its members, officers or directors. However, reasonable salaries and expense reimbursements are permitted.
• Nonprofit corporations must pay taxes on income from “unrelated activities.” Sometimes, a nonprofit organization will earn income through activities that aren’t directly related to its nonprofit purpose; for example, the directors of an organization dedicated to preserving open space may collect a consulting fee for advising other nonprofits. The IRS requires nonprofits to pay corporate income taxes on such unrelated income over $1,000, whether or not the group uses that money to fund its tax-exempt activities. For more information on unrelated activities, see Earning income as a nonprofit corporation.
• Nonprofit corporations cannot make substantial profits from unrelated activities. If a nonprofit spends too much time on unrelated activities, or if the unrelated activities generate “substantial” income, the group’s nonprofit status may be jeopardized. Nonprofit corporations that plan to engage in activities that aren’t related to their tax-exempt purpose should consult a lawyer or tax expert with experience in nonprofit law. For more information on unrelated activities, see Earning income as a nonprofit corporation.
• When a nonprofit corporation dissolves, its assets must be distributed to another tax-exempt group. Since tax-exempt organizations and their assets cannot be owned, they can never be sold. If the directors of a nonprofit decide to disband the organization, they must donate its assets to another nonprofit group. This also means that once property goes into a nonprofit corporation, it cannot later be distributed to a member or director.

Copyright © Nolo

If you’re involved in a fledgling nonprofit organization, you and the other folks active in the group have probably wondered whether or not you should incorporate. Becoming a nonprofit corporation requires some paperwork, but for many groups, the benefits of nonprofit status outweigh the complications. Here are five circumstances that may make it worth your while to incorporate.

Your association makes a profit from its activities
If your group will make a profit from its activities, becoming a nonprofit corporation can yield a great benefit: As long as the money you make is related to your charitable activities, your nonprofit corporation won’t pay income tax on it.

Example
Better Books and Learning begins as a part-time effort by a few dedicated individuals to hold book groups for disadvantaged youth. The volunteers pay all of the expenses out of their own pockets, and the group never turns a profit. Then a board member of a local junior college asks the group to administer and run book groups as part of the college curriculum — for a fee. Since the group will now show a profit from its educational activities, it decides to incorporate as a nonprofit and seek tax-exempt status with the IRS.

For more information on whether income is “related” to your group’s activities, and thus not taxable, see Earning income as a nonprofit corporation.

You want to apply for public or private grant money
Without tax-exempt status, your group is unlikely to qualify for many public and private grants. While you can form a nonprofit, tax-exempt association, rather than a corporation, qualifying for a tax exemption as an association is harder — it requires preparing and adopting a complicated set of organizational papers and operating rules. Further, it’s generally easier to get the IRS to approve a tax exemption for a nonprofit corporation.

You want to solicit tax-deductible contributions
If your organization becomes a tax-exempt nonprofit corporation, donors can deduct their gifts to your group on their federal and state tax income returns.

Example
For Shore United wants to sponsor monthly cleanup drives to pick up and haul away trash left along the local bay shore. They’ve enlisted a sufficient number of enthusiastic volunteers, but they need funds to rent a truck, buy gas and pay for volunteers’ meals. They know that many people in the community would chip in to help fund their effort if their group was a recognized public charity eligible to receive tax-deductible contributions. Incorporating the group as a nonprofit corporation and applying for tax-exempt status can help them raise these much-needed funds.

You want protection from personal liability for the group’s activities
If your group finds itself the target of a lawsuit, incorporation can provide welcome peace of mind. Nonprofit corporations can be sued — but their members and directors are generally protected from personal liability, meaning that their own money, houses, cars or other property isn’t at risk. That’s not true of an unincorporated association.

Example
Engineers for the Environment is a nonprofit consulting firm that helps developers prepare environmental impact reports for nonprofit housing developments. To avoid legal liability if unforeseen federal and state guidelines cause costly delays, the firm decides to incorporate their organization as a nonprofit.

Your advocacy efforts might provoke legal quarrels
Although nonprofits may engage only in very limited political advocacy (unless they elect to follow special federal lobbying rules), advocacy efforts may occasionally draw a nonprofit into an unwanted lawsuit. Incorporating can support directors and officers in defending the lawsuits and protect them from personal liability.

Example
Citizens for a Smoke-Free America informs the public about the health hazards of secondary smoke from cigarettes. The group decides to campaign for local legislation banning cigarette advertising on billboards in the community. It expects an unfriendly response from cigarette advertisers in the form of expensive and time-consuming lawsuits against the organization, and its directors and officers. The group decides to incorporate before beginning the campaign, to allow the corporation to pay the officers’ and directors’ legal expenses and to insulate the directors and officers from personal liability.

Additional benefits of organizing a nonprofit
Although these aren’t the main reasons people form nonprofit corporations, nonprofits can take advantage of other benefits, including:

• Special postage rates. Nonprofits can apply for and receive a mailing permit that gives them a special reduced nonprofit rate for mailings. This is especially helpful for organizations that will do a lot of solicitation by mail.
• Property tax exemptions. In addition to an exemption from income taxes, nonprofits are usually exempt from paying property taxes on real estate and other property. Contact your county assessor’s office for more information on this property tax exemption, which is called a “welfare exemption.”

To learn more about forming a nonprofit corporation, see How to form a nonprofit corporation.

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While diligently filing articles of incorporation and adopting bylaws, many corporate owners overlook a critical element of their business relationship: buy-sell, or buyout, provisions. By creating a shareholders’ agreement with buy-sell provisions, the owners of a small, privately held corporation can prepare for events that have been the downfall of more than a few successful small businesses — namely, the death, divorce, bankruptcy or retirement of one of the owners.

What are buy-sell provisions?
Contrary to popular belief, buy-sell provisions don’t have anything to do with buying and selling companies; instead, they control when and how shares in a corporation can be bought and sold. Shareholders include these provisions in a written document called a shareholders’ agreement or a buy-sell agreement. (Although you can also include these provisions in your corporate bylaws, it’s easier, and more legally sound, to create a separate agreement.) Typically, this agreement controls the following business decisions:

• who can buy a departing shareholder’s stock (this may include outsiders or be limited to other shareholders)
• what events will trigger a buyout (see the list below), and
• what price will be paid for a shareholder’s interest in the corporation.

It may help to think of a buy-sell agreement as a sort of “premarital agreement” between you and your co-owners.

What events should you cover in a shareholders’ agreement?
Your shareholders’ agreement will instruct and remind you and your co-owners how you have agreed to handle the sale or buyback of shares from a shareholder whose circumstances have changed. Typically, the events that trigger a buyout of a shareholder’s interest are:

• an attractive offer from an outsider to purchase a shareholder’s interest in the corporation
• a divorce settlement in which a shareholder’s ex-spouse stands to receive all or part of a shareholder’s stock of the corporation
• the foreclosure of a debt secured by a shareholder’s stock
• the personal bankruptcy of a shareholder, or
• the disability, death or incapacity of a shareholder.

Why you need a shareholders’ agreement
It’s a huge mistake to ignore the fact that sooner or later your business will change. If you doubt this even for a minute, think about what would happen if you don’t create a buy-sell agreement and one of the following occurs:

• One shareholder quits to move to another city or leaves to start another business. Without an agreement, you must decide whether you should buy out the departing shareholder’s ownership interest, and for how much. If you’re the shareholder who wants out, without an agreement you won’t be able to force your co-owners to buy you out.
• One shareholder dies, gets divorced or becomes mentally or physically incapacitated. In this case, you might have to work with the spouse or other family member of a deceased, disabled or divorced shareholder. There is a substantial possibility that the family member would be inexperienced or otherwise unable to act in the best interests of the business. On the flip side, you (or your family) might get stuck with a small business interest that no outsider wants to buy and for which no insider will give you a decent price.
• One shareholder sells his or her share to a stranger or to someone you know well and can’t stand. In this case, you may be forced to share control of the company with an inexperienced or untrustworthy stranger — or you’ll be faced with the struggle of running a business with someone you’d rather not even see on the street.

Just looking at this list, it should be obvious that if you don’t anticipate and plan for circumstances like these, you’re risking serious personal and business discord — perhaps even court battles and the loss of your business.

Creating a shareholders’ agreement
To create the buy-sell provisions for your shareholders’ agreement, you can use either a self-help resource or see a lawyer — or both. One good tool is Business Buyout Agreements: A Step-by-Step Guide for Co-Owners, by attorneys Anthony Mancuso and Bethany K. Laurence (Nolo.com) which contains a disk with a fill-in-the-blank buy-sell agreement. Even for those who want the services of a lawyer, this book walks you through the necessary discussions with your co-owners, so you can decide on your own time — not your lawyer’s — which terms you want to include.

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Many business partners overlook a critical element of their partnership agreement that can save them both money and angst: buy-sell provisions. When you create buy-sell, or buyout, provisions for your partnership agreement, you and your partners can prepare for events that have been the downfall of more than a few successful small businesses — namely, the death, divorce, bankruptcy or retirement of one of the owners.

What is a buy-sell agreement?
Contrary to popular belief, a buy-sell agreement is not about buying and selling companies; rather, it is a binding contract between business partners. A buy-sell agreement is made up of several clauses in your written partnership agreement (or it can be a separate agreement that stands on its own) that control the following business decisions:

• who can buy a departing partner’s share of the business (this may include outsiders or be limited to other partners)
• what events will trigger a buyout (see the list below), and
• what price will be paid for a partner’s interest in the partnership.

It may help to think of a buy-sell agreement as a sort of “premarital agreement” between you and your co-owners.

What events should you cover under a buy-sell agreement?
Your buy-sell agreement will instruct and remind you and your partners how you have agreed to handle the sale or buyback of an ownership interest when one partner’s circumstances change. Typically, the events that trigger a buyout of a partner’s interest under a buy-sell agreement are:

• an attractive offer from an outsider to purchase a partner’s interest in the company
• a divorce settlement in which a partner’s ex-spouse stands to receive an ownership interest in the company
• the foreclosure of a debt secured by an ownership interest
• the personal bankruptcy of a partner, or
• the disability, death or incapacity of a partner.

For fill-in-the-blank buyout clauses and instructions on how to incorporate them into your partnership agreement, see Business Buyout Agreements: A Step-by-Step Guide for Co-Owners, by attorneys Anthony Mancuso and Bethany K. Laurence (Nolo.com).

If you don’t create a buy-sell agreement
When starting a new business, you may think that the last thing you have time for is worrying about what will happen when you or another owner wants out — or worse, dies. But it’s a huge mistake to ignore the fact that sooner or later your business will change. If you doubt this even for a minute, think about what would happen if you don’t create a buy-sell agreement and one of the following occurs:

• One partner quits to move to another city or leaves to start another business. Without an agreement, your partnership might, by law, be dissolved, forcing you to divide any assets and profits among the partners and decide whether to start a new partnership with the remaining partners. Even if your partnership doesn’t end, you will still have to decide whether you should buy out the departing partner’s ownership interest, and for how much.
• One partner dies, gets divorced or becomes mentally or physically incapacitated. In this case, you might have to work with the spouse or other family member of a deceased, disabled or divorced owner. There is a substantial possibility that the family member would be inexperienced or otherwise unable to act in the best interests of the business. On the flip side, you (or your family) might get stuck with a small business interest that no outsider wants to buy and for which no insider will give you a decent price.
• One partner sells his or her share to a stranger or to someone you know well and can’t stand. In this case, you may be forced to share control of the company with an inexperienced or untrustworthy stranger — or you’ll be faced with the struggle of running a business with someone you’d rather not even see on the street.

Just looking at this list, it should be obvious that if you don’t anticipate and plan for circumstances like these, you’re risking serious personal and business discord — perhaps even court battles and the loss of your business.

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If you and your partners don’t spell out your rights and responsibilities in a written partnership agreement, you’ll be ill-equipped to settle conflicts when they arise, and minor misunderstandings may erupt into full-blown disputes. In addition, without a written agreement saying otherwise, your state’s law will control many aspects of your business.

How a partnership agreement helps your business
A partnership agreement allows you to structure your relationship with your partners in a way that suits your business. You and your partners can establish the shares of profits (or losses) each partner will take, the responsibilities of each partner, what will happen to the business if a partner leaves and other important guidelines.

Uniform partnership act
Each state (with the exception of Louisiana) has its own laws governing partnerships, contained in what’s usually called “The Uniform Partnership Act” or “The Revised Uniform Partnership Act” — or, sometimes, the “UPA” or the “Revised UPA.” These statutes establish the basic legal rules that apply to partnerships and will control many aspects of your partnership’s life unless you set out different rules in a written partnership agreement.

Don’t be tempted to leave the terms of your partnership up to these state laws. Because they were designed as one-size-fits-all fallback rules, they may not be helpful in your particular situation. It’s much better to put your agreement into a document that specifically sets out the points you and your partners have agreed on.

What to include in your partnership agreement
Here’s a list of the major areas that most partnership agreements cover. You and your partners-to-be should consider these issues before you put the terms in writing:

• Name of the partnership. One of the first things you must do is agree on a name for your partnership. You can use your own last names, such as Smith & Wesson, or you can adopt and register a fictitious business name, such as Westside Home Repairs. If you choose a fictitious name, you must make sure that the name isn’t already in use.
• Contributions to the partnership. It’s critical that you and your partners work out and record who’s going to contribute cash, property or services to the business before it opens — and what ownership percentage each partner will have. Disagreements over contributions have doomed many promising businesses.
• Allocation of profits, losses and draws. Will profits and losses be allocated in proportion to a partner’s percentage interest in the business? And will each partner be entitled to a regular draw (a withdrawal of allocated profits from the business) or will all profits be distributed at the end of each year? You and your partners may have different ideas about how the money should be divided up and distributed, and each of you will have different financial needs, so this is an area to which you should pay particular attention.
• Partners’ authority. Without an agreement to the contrary, any partner can bind the partnership without the consent of the other partners. If you want one or all of the partners to obtain the others’ consent before binding the partnership, you must make this clear in your partnership agreement.
• Partnership decision-making. Although there’s no magic formula or language for divvying up decisions among partners, you’ll head off a lot of trouble if you try to work it out beforehand. You may, for example, want to require a unanimous vote of all the partners for every business decision. Or if that leaves you feeling fettered, you can require a unanimous vote for major decisions and allow individual partners to make minor decisions on their own. In that case, your partnership agreement will have to describe what constitutes a major or minor decision. You should carefully think through issues like these when setting up the decision-making process for your business.
• Management duties. You might not want to make ironclad rules about every management detail, but you’d be wise to work out some guidelines in advance. For example, who will keep the books? Who will deal with customers? Supervise employees? Negotiate with suppliers? Think through the management needs of your partnership and be sure you’ve got everything covered.
• Admitting new partners. Eventually, you may want to expand the business and bring in new partners. Agreeing on a procedure for admitting new partners will make your lives a lot easier when this issue comes up.
• Withdrawal or death of a partner. At least as important as the rules for admitting new partners to the business are the rules for handling the departure of an owner. You should set up a reasonable buyout scheme in your partnership agreement. To learn more about this issue, read Plan for changes in partnership ownership with buy-sell provisions.
• Resolving disputes. If you and your partners become deadlocked on an issue, do you want to go straight to court? It might benefit everyone involved if your partnership agreement provides for alternative dispute resolution, such as mediation or arbitration.

As you can see, there are many issues to consider before you and your partners open for business — and you shouldn’t wait for a conflict to arise before hammering out some sound rules and procedures. A good self-help book, such as The Partnership Book, by attorneys Denis Clifford and Ralph Warner (Nolo), can help you think through the details and put them in writing.

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