Corporate / M&A

Do Limited Liability Companies Actually Need Share Capital?

The authors present the pros and cons of share capital in limited liability companies and briefly explain why it is becoming less important.

Share capital as the legal basis of the limited liability company

The limited liability company is the “classic” company type in almost every jurisdiction. There might be some differences in details, but the general principles stay the same. A substantial minimum amount of registered share capital used to be one of the core features of limited liability companies. But more and more, jurisdictions are moving away from the obligation to maintain registered share capital at a minimum regulatory level, or are establishing a low minimum share capital level.

For example, in France minimum share capital is EUR 1 (previously EUR 7,500). Similar amendments were introduced in the Netherlands, Finland, Portugal, Estonia, Ireland, and more.

Poland

Also in Poland there are currently advanced discussions on eliminating the statutory obligation to maintain registered share capital on a certain level in limited liability companies. The first step was in 2009, when the minimum registered share capital was decreased from PLN 50,000 (ca EUR 12,500) to PLN 5,000 (ca EUR 1,250). There have been several other proposals for amending the Polish Commercial Companies Code (CCC) on the required amount of registered share capital, but so far none have been positively received by the Polish Parliament.

Share capital generally

In general, share capital can be defined as the sum of the nominal value of all shares in the company. It determines the total sum of shareholder liabilities to the company to make contributions to it. In accounting, share capital is recorded in the balance sheet as a liability.

Share capital versus company assets

Share capital is not the same as company assets. Share capital is only one component of the company’s assets and, therefore, does not provide credible information about the company’s financial condition. What it actually presents is the minimum value of company assets. This distinction is also important because the company is responsible for its liabilities towards third parties with all its assets, not just its share capital. The registered share capital may remain the same irrespective of real changes in the company’s assets or financial situation. No regulation requires a limited liability company to decrease its share capital when it incurs losses, or to increase its share capital when it generates profits.

Doubtful protection of company creditors

One of the initial purposes of share capital was to protect the company’s business partners and creditors. In practice, this does not work. A company with high share capital can be insolvent, and a company with the minimal share capital can own assets far more valuable than such capital. Moreover, no provision requires the company to maintain funds to cover share capital during its business activity. For the company’s creditors the more important information is its financial liquidity, which is not in any way reflected in the amount of the share capital.

What protects creditors if not share capital?

Only significantly high minimum share capital would play a real guarantee function for creditors. But an increase in minimum share capital would restrict the availability of this type of company, currently the most popular legal form among entrepreneurs.

The company’s real financial situation is presented in its financial statements, which under Polish law must be submitted annually to the registry court. However, many companies do not fulfil this obligation, and registry courts do not force them to submit financial statements.

One of the planned amendments to the CCC is an obligation to create supplementary capital, to which a certain amount would have to be transferred annually from the profits. The amount of the supplementary capital would differ depending on company liabilities and, therefore, would reflect the company’s real activity and better protect creditors.

Another envisaged amendment is introducing a solvency test. Such a test would have to be carried out before paying dividends to shareholders, and the management board would have to confirm that paying dividends would not influence the company’s ability to fulfil its obligations.

Conclusion

As shown, making use of the available methods by the registry courts, together with the implementation of further protection measures, would secure the creditors better than requiring high share capital.

More and more, jurisdictions are moving away from the obligation to maintain registered share capital at a minimum regulatory level, or are establishing minimum share capital at a low level.