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Why is an investment contract needed?

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Quick Answer

An investment contract defines the rights and responsibilities of investors and host governments in a project, according to NASDAQ. It is also used to specify and protect the interests of investors in a business, according to Rocket Lawyer. The document is also known as an investment agreement or a shareholders agreement. Among other things, investment contracts are used to forestall or solve disputes between parties to the document.

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Full Answer

According to Wikipedia, an investment contract should pass the Howey test. A contract that fulfills the test must have four elements, which include a third party, typically the person requiring financial backing to start a business; a common enterprise, typically the business; the investment, which includes equipment and land in addition to money; and an expectation of profits. The test was crafted by Supreme Court Justice Murphy in 1946 as a way of fleshing out the Securities Act of 1933, which at the time did not clearly spell out what constituted an investment contract. The name "Howey" was derived from the defendant in the case, the W.J Howey Company.

According to Rocket Lawyer, an investment contract defines, among other things, the dividend distribution formula, the entity responsible for running the business and the number of shares that each investor holds.

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