Equity in red – how to rebuild your net worth?

You enter the Commercial Register and see a warning under your notifications, “A ruling of warning for compulsory dissolution: insufficient net assets,” giving you six (6) months to bring your equity (net assets) into line with the legal requirements. Let’s take a closer look at what this means.

Liquidate or recapitalise

Negative equity means that the equity does not meet the requirements of the Commercial Code. The company’s assets are insufficient to cover all its liabilities. If the net assets of a limited liability company fall below the minimum threshold (€2,500), the shareholders must take steps to restore the equity. These steps include reducing or increasing the share capital, the decision to dissolve, merge, divide or reorganise the company, or file for bankruptcy. The law also allows taking other remedies which would bring the net assets in line with the law but do not specify what these other remedies may be. In practice, one such remedy is contributions to a voluntary reserve. Next, we will look at restoring net assets through a voluntary reserve.

What is a voluntary reserve?

The law provides a requirement for legal reserve, which is not compulsory for limited liability companies, and the possibility to set up additional reserves. The voluntary reserve is one of the possible additional reserves. As it is a supplementary voluntary reserve, the law does not provide very detailed guidance on the reserve, and shareholders have independence in determining its composition, contributions, and use.

Formation of a voluntary reserve

The formation of a voluntary reserve is subject to the provision of the respective legal reserve in the company’s articles of association. In addition, the articles of association must stipulate the contributions that may be made to the voluntary reserve, how these contributions are to be assessed, how payments from the voluntary reserve are to be made, and how the voluntary reserve may be used. The advantage of a voluntary reserve over share capital or legal reserve is the possibility to return to the shareholders’ contributions made to the voluntary reserve, provided that the minimum amount of net assets of a limited liability company required by the Commercial Code is guaranteed after the payment without any change in the share capital.

Making a contribution

Shareholders must then make a contribution to the voluntary reserve. The contribution may be monetary or non-monetary, as specified in the articles of association. A non-monetary contribution could be, for example, the conversion of a loan granted by the shareholder to the company into a voluntary reserve. It should be noted that when loans are converted into a voluntary reserve, interest on the loan amount is no longer credited to the lender. Thus, if you wish the interest income not to be lost, the loan could be converted into voluntary reserve partially rather than in full, depending on the recapitalisation needs of the company.

It is also important to note that while the documents for the increase of share capital must be filed with the Commercial Register, the formation of a voluntary reserve does not affect the composition of the data entered in the Commercial Register. Hence, no application to the register is necessary. However, recording the voluntary reserve in the company’s accounts and annual reports is necessary.

Hedman advises setting up a voluntary reserve

Please contact us if you need to rebuild your net worth or are interested in setting up a voluntary reserve for any other reason.

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