Designing operating procedures: it takes camaraderie and a formal written commitment to run a profitable club.

You already know that an investment club is a terrific low-risk, low-cost way for novice investors to profit from stocks, bonds, mutual funds and other investments. What's ideal about these close-knit groups of friends or colleagues is that a club can better diversify its portfolio than an individual investing on his or her own.

In the first part of this series (October 1996), you learned how to go about selecting like-minded individuals to join your club. The next phase is to iron out the thorny details, such as the club's legal structure. You'll also need to elect officers assigned individual responsibilities. You may even want to appoint a committee to handle certain transactions. All of this should be a part of your formal operating procedures and bylaws.

Legal Form: Rather than incorporating, which demands tons of paperwork, most clubs are formed as partnerships. Easier to maintain, a partnership also minimizes taxes since as such you are not technically required to file a tax return every year. However, each member must report investment income or losses on their individual tax returns.

Before choosing a legal structure, members should discuss the following five questions. Under which organization would they: (1) pay the least amount in taxes from the time money was earned until they began receiving it; (2) minimize their financial risk; (3) see their securities transferred with the least need for supporting resolutions; (4) minimize the cost of setting up the club; and (5) enjoy the most economical arrangement, in terms of both time and money, over the dub's lifetime?

Officers: You should count on electing at least five officers--a president, vice president, treasurer, assistant treasurer and secretary. The president or presiding partner is responsible for setting the time and place for the meetings, appointing committees, presiding over meetings and overseeing the activities of the dub. The vice president not only takes the place of the president when the latter is unable to serve, but usually also leads the investment education program. The recording partner (secretary) keeps minutes of proceedings and notifies members of the time and place of meetings. Typically, the secretary assumes responsibility for notifying absent members of club actions by mailing copies of minutes. The financial partners (treasurer and assistant treasurer) maintain the club's financial records and place buy-and-sell orders with the broker. Recordkeeping includes an accounting of dub receipts and disbursements and calculation of each member's share of interest in the dub. The financial partners also prepare a monthly liquidating statement and file an annual informational tax return with the federal government. Ideally, the treasurer should keep track of deposits and interest and the assistant treasurer should record all purchases. The financial partners should obtain an accounting kit from the National Association of Investors Corp. (810-583-NAIC). The kit will make the entire financial reporting job much easier.

Some clubs operate via a three- to five-tier committee structure. These groups can range from two or more members, who are often responsible for specific areas (i.e., the executive, investment and research committees).

Name: Once you have identified officers, you'll want to come up with a name for the group. Pick a first and second choice--just in case another club may be doing business under that name. Also, consider joining a national group. There are a number of benefits to belonging to NAIC, since the organization offers a series of reading materials, stock study programs and investment plans.

Agreement: With respect to the operating agreement--a written statement of your club's procedures and processes--there are several things you need to take into consideration beforehand. One is the purpose of the group. Are you going to invest strictly in bonds and/or stocks or in other securities, such as real estate? Second, how often will you hold meetings--biweekly, monthly or bimonthly? Most clubs meet on the first or third business day of each month. Third, what is the maximum contribution any member can make and how will members share in the profits or losses? In general, partners make a regular contribution at each meeting and it's usually a fixed amount. Since change is inevitable, you'll need to make allowances for members who leave the club and those who join down the road. To prevent any member(s) from becoming a majority owner, you may want to limit the percentage of shares they own.

That said, you'll need to determine how and when partners can be removed or leave the group as well as how and when additional partners can be admitted. Can any partner withdraw a part or all of the value of their contributions to the account in the partnership? How will you determine the value of new deposits?

Six years ago, a group of 20 investors formed the M.O.D.E.L. Club (Managing Our Dollars, Earnings and Learnings) in Sacramento, California' Today, only eight members remain, none of whom were founders. "Some of them left to join other clubs, others moved away," says Gary D. King, an NAIC council president. "Under the club's original agreement, we opted to pay out the fleeing club members in securities rather than cash. So, whereas we started with 10 securities, we now own shares in the [including Pepsi, Intel and Aetna]," he explains.

A final consideration is the termination of the partnership. Under what circumstances will the club cease to exist and how will payments be made to members? You should consult a lawyer or accountant about filing the actual paperwork. The NAIC's kit has a step-by-step guidebook for drafting an agreement.

Next month, BE will focus on determining your investment strategy and how to set up bank and brokerage accounts.