This is a short introduction to equity among the different company forms including the difference between equity and foreign capital.
What is equity?
Equity is a company’s collective assets, excluding obligations and debt. Equity typically consists of the shareholders’ participation as shown in the shareholders’ registry including the surplus not paid out to the shareholders. A company’s equity is calculated in the annual financial statement which is approved by the ordinary general assembly. This is, in other words, a statement of changes in equity.
Equity and company forms
For several company forms, there is a minimum amount of equity that has to exist. Entrepreneurial companies only need 1 DKK while limited liability companies need 50,000 DKK and joint stock companies need 500,000 DKK in equity. Please note that these amounts may vary from one country to another. That is one of the reasons why you have to include the company form in its name - for example LLC or JSC. This enables customers and vendors to decide whether they want to work or trade with the company.
In case the equity drops below 50 % of these minimum amounts, the company has a big problem and management has to explain how they plan to find the equity.
Personally owned companies like a sole proprietorship do not need equity. Thus, it typically consists of accumulated surplus from earlier years. Therefore, equity is a surplus that is not distributed but instead acts as a reserve that is held back. If a company is registered but inactive and the equity thus only increases with interest, it is called a shell corporation.
Equity and foreign capital
Contrary to equity, foreign capital is the capital provided by the company’s creditors and lenders. Foreign capital commonly comes from banks, mortgage credit institutions or vendors. Thus, it is a form of external financing that is not included in equity. This kind of capital is usually necessary in the early years of a company’s existence - so for start-ups and entrepreneurs.
When undertaking a due diligence or a SWOT analysis you will, among other things, see the relation between equity and foreign capital. You then divide the company’s foreign capital with its equity. Thereby, you find the equity’s leverage which is an important key number. The lower the gearing - the better the creditworthiness. High leverage implies that the company is vulnerable.