What to do if equity does not meet the requirements

When compiling the annual report, so many companies may be frightened by discovering that equity does not meet the requirements prescribed by law. We can explain in more detail how equity can become negative and what to do in such cases.

Amount of equity 

The concept of equity is often confused with share capital, although these two are different in content. Equity is the property of the company and the owner of the company. This is the amount that remains of the assets after the liabilities have been paid. However, the part of the equity that is registered in the commercial register is called share capital. The size of the share capital is usually 2,500 euros, but it can also be bigger.

Equity = net assets = assets – liabilities

The amount of equity is regulated by the Commercial Code. The requirements are designed to protect creditors so that the company can meet its obligations. The amount of equity depends on the share capital payment and the amount of share capital:

• if the share capital has not been paid in, the equity must be at least 0
• if the share capital is in the amount of 2500-5000 euros and paid up, the equity must be at least 2500
• if the share capital exceeds 5000, the equity must be at least 50% of the share capital.
  

How can equity become negative?

In general, equity falls below the required level in these two cases:

1. You have outstanding invoices or loans to others. 
2. As the owner you have added money to the company to pay the invoices and loans of others, i.e. a large part of the liabilities is actually the loan granted by the owner.

If you have a lot of unpaid invoices at the end of the year, you should seriously look in the mirror – does it still make sense to continue with the company in this way. If you have already added money to the company to pay off the invoices and loans of others, it is easier to solve the problem, as you can raise the loan granted by the owner from liabilities to equity.

If, when compiling the annual report, it turns out that the equity is not large enough, then an explanation must be attached to the annual report on how the deficit is to be covered – whether it is planned to do so at the expense of profit, the owner makes an additional contribution, etc.

In autumn you will most likely receive an angry letter from the commercial register that the company’s equity does not meet the requirements. This message should definitely not be ignored, otherwise deleting of the company will follow! If you have re-adjusted the equity in the meantime, send a new balance sheet to the commercial register and the matter will be resolved. If the equity is still below the required level, provide the register with the owner’s decision or explanation on how the equity deficit will be eliminated and which are the future plans of the company.

Possible solutions for complying the equity

Monetary contribution

Monetary contribution is the most common option. This is often most reasonable, especially if the invoices are to be paid and you want to continue with your business. When making a monetary contribution, it might be preferable not to increase the share capital, because the larger the share capital, the higher the equity requirements. The usual practice is to increase the share capital by 1 euro, the rest moves to the share premium line.

Non-monetary contributions

If the owner has granted a loan to the company, this loan can be transferred from liabilities to equity, if necessary. This is called non-monetary contribution which usually requires an amendment to the articles of association. Check if your articles of association allow a non-monetary contribution, if not, initiate a change.

If there is a situation where the equity is out of place, but no additional money is directly needed in the company, the equity can also be increased by registering additional equipment or assets. For example, if you have a computer or printer that is yours as an owner, but also used professionally, the management board must evaluate the computer and set a realistic price for it, after which it can be recorded in the balance sheet. All kinds of equipment are suitable for non-monetary contributions, as well as, for example, a loan issued as a private person.

Voluntary reserve

The voluntary reserve is similar to a non-monetary contribution, except that the money is not transferred to the share capital and share premium line, but to the reserve line. In general, the voluntary reserve is more a matter for larger companies, it has strict rules and it certainly requires an amendment to the articles of association. The share capital will not be affected.

Waiver of loan

The easiest option. The share capital does not change, no legal documents need to be drawn up and it is not necessary to submit anything to the commercial register. All you have to do is send an e-mail to your accountant saying that you waive your claim as the sole owner and then move to the revenue line. Very simple.

However, there is one definite reason why it should not be done too lightly. Namely, if in case of monetary and non-monetary contributions, you can get this money back tax-free in the future if you wish (provided that these have been declared to the tax board), then the waived loan amount cannot be withdrawn tax-free. This is only useful if there is a strong need for a positive income statement. Although anyone who can read numbers can see it anyway, because it stands out.

How to prevent equity from becoming negative?

There are a number of steps you can take proactively to prevent your equity from becoming negative. Most of these are the activities that you can do at the end of the year, not by preparing an annual report afterwards.

The best time to check the amount of equity is in October-November. If you feel that your equity tends to be low, you can usually make some more changes:

• make an additional sales invoice in December – sometimes it is possible to set a bit whether you submit an invoice at the beginning of January or at the end of December;
• postpone some of the expenses to the beginning of the year – if the equity minus threatens, see if any of the expenses you plan to make in November-December could be postponed to January; 
• check whether any expense could be on the fixed assets line – a phone costing 500 euros can also be placed in fixed assets and divided into 2 years; the limit is up to you;
• review the depreciation rates of fixed assets – many do not know that these can be changed themselves; for example, if you originally planned to use a computer for 2 years, but now you want to use it for an additional +2 years, redistribute the depreciation;
• collect unpaid invoices – if something is left undone, now is the time to prepare reminders;
• review whether any assets need to be written off – there should be no assets in the balance sheet that you no longer actually have or that you do not use; if there are problems with equity, check if there is anything to write off, such as an uncollectible invoice from years ago.

If you have any questions regarding equity, write to krista.teearu@robbybobby.ee. Often, equity issues are quite on the frontiers of accounting and law. But since I have learned both, I can hopefully help you.