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I have a few interested friends and family that are looking to invest money. They come with various backgrounds/experiences in investing but given a connection they are willing to try a different investment.

I have been wanting to set up a business and generate some cash flow, myself. I see a good alignment in these goals. I'd like to do something like the following:

  1. Connect with friends/acquaintances or 2nd degree connects through them.
  2. Agree on the investment amount, duration and gains/percentage.
  3. Deploy the money, get the gains from various investments, keep a cut and grow the business.
  4. Keep the contracts/return principal plus gains of individual investors.

On the point of 3, I have a few avenues which are, in turn, friends/family where they need capital to scale their operations and they will commit to some interest/dividends from their side.

One such investment could be a day trader in the stock market. Another could be a loan to a nearby farmer who will commit to some percentage back. (Of course these come with risks and there should be some language in the contracts.)

From my side to my investors I may need to do a Schedule K-1 or a 1099-INT or some such thing, but in the case of that farmer, if it is a cash deal and I get back cash, is that okay? Or do I need to insist on tax docs from the farmer/local business person or even the stock trader?

Is a Manager managed LLC the best way to do this? Or should I do this as a bank like structure that offers interest on principal? That way I can simply issue 1099-INT (if I understand correctly).

Location: California, USA Opening it to non-accredited investors too.

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    Not sure I can see a reason they'd want to pay the overhead of, essentially, having another layer of broker between them and the investment. Where's the value add they'd be paying you for,?
    – keshlam
    Feb 23 at 11:52
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    I’m voting to close this question because it (and its answers) are veering far from personal finance and money into how to set up a consortium of investors or an investment company, and thus are off-topic for money.SE. Migrate to startup.SE?
    – Dilip Sarwate
    Feb 23 at 14:42
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    @DilipSarwate - This is personal finance. I am personally looking to start something to invest and I stand to gain financially (or lose if done incorrectly). All the structures and investment company conversation is still with an individual in focus. It is as personal as a question around leasing-vs-owning or investing through self-directed IRA or not. The Q also doesn't ask how Berkshire Hathaway issues shares or how dividends vs interest work. Any chance you'd consider rescinding your vote?
    – perennial_noob
    Feb 23 at 17:18
  • Also, there is no startup.SE.
    – perennial_noob
    Feb 23 at 17:21
  • @keshlam - my value add is that I have different types of investment opportunities that I have studied (and often invested my own money in). There are others who may not want to or don't have time to study all those in depth but can trust me. The gains (even with my cut) are higher than they'd get in CDs but they also don't have to wait for multiple years like in VC funds.
    – perennial_noob
    Feb 23 at 17:31

2 Answers 2

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You're talking about an investment fund. Legally, these are usually partnerships ((G)P, LP, LLP, LLLP, or LLC). Which one specifically would depend on the specific details of your organization, and the State law under which you're organizing. You'll want to talk to a lawyer about that.

From tax perspective all the above entities are taxed the same - you file an informational form 1065 with the IRS (and a similar form with the State(s)), and allocate the income and expenses to each partner using Schedules K-1 which they will then use to report and pay taxes on the income.

You might need to check what regulations there are specifically for investment funds. You can start here (SEC on Private Funds and regulation D), and probably should discuss this with a specialist attorney.

In California LLPs are for professional partnerships (lawyers and accountants). So you would probably go with LP or LLLP. You wouldn't want to have a (G)P (a "General" partnership, i.e.: a partnership where all the partners are the same) as it exposes your investors to potential liability and responsibility for debts.

Any limited liability entity (corporation, LLC, or any of the various variants of limited partnerships) has to pay at least $800/year to the State. Corporations pay taxes on their income (including S-Corp, at 1.5% rate), LLCs pay a fee based on their gross receipts (note the difference), so partnerships are the most tax-efficient entity for your purposes in California.

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  • It looks like LLLP is not allowed in CA (the FTB link states so). LP or LLC is more or less where I narrowed it. My main concern with LP is that I will be the GP and that I personally will be liable.
    – perennial_noob
    Feb 23 at 6:51
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    My other question is, is this looking a lot more like a Credit Union or small bank where investors are going to get interest on their principal much like a CD and my business entity gives out loans to others and generates yield (interest)?
    – perennial_noob
    Feb 23 at 6:59
  • @perennial_noob to work around the GP problem, you can create a limited liability entity (LLC or SCorp) to act as the GP. It will cost extra $800, but otherwise would be disregarded unless the GP earns enough to start paying SCorp taxes or LLC fees based on income.
    – littleadv
    Feb 23 at 7:10
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    @perennial_noob banks and credit unions are corporations, and are regulated much more than any other entity.
    – littleadv
    Feb 23 at 7:11
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To be an issuer of company stock then look at SEC Rule 504 or at the exception to Rule 506. Then with the IRS, the company can be a C-corp or S-corp.

Now a multi-member LLC is not an issuer but just accounts member percentages. I suppose that as long as there is no public promotion then much of the regulation is avoided.

But if an issuer company were identified as an investment company there there would be enormous regulation.

In any case the formation of the company is with a state.

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  • It cannot be S-Corp since S-Corps are not intended for investment companies. Creating an investment company as a C-Corp doesn't sound right to me, why would you want to double-tax the gains?
    – littleadv
    Feb 23 at 5:31
  • Trader-status companies are in the news as choosing between S-corp and LLC. No one here is creating an investment company as defined by federal regulation.
    – S Spring
    Feb 23 at 5:34
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    But then you only have one class of shares and limited number of investors who all have to be US tax residents. The first part would be a big problem for many investment funds. And the OP would lose the huge tax break that the fund managers have on their compensation...
    – littleadv
    Feb 23 at 5:49
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    A. you said S-Corp systematically pays a dividend - that's incorrect. You're now correcting your prior statement. B. cash distribution would not necessarily be expected by the shareholders, especially not if the goal is investments. C. what's the benefit in S-Corp over partnership then? Why are you suggesting the OP to create something complicated and expensive to get the same result they can get with something cheap and simple?
    – littleadv
    Feb 23 at 6:19
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    Berkshire Hathaway is a public company with multiple classes of shares, not a family & friends investment fund.
    – littleadv
    Feb 23 at 6:33

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