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What if a limited company's equity goes into the red?

What should an entrepreneur do if the company's equity goes into negative territory?

The equity of a limited company is the thermometer of business performance. When there are good results, there is profit. This profit can be deposited in company's equity, thus increasing the company's equity. The company's profit for the financial year can also be distributed in the following year as dividends to shareholders if the equity does not need to be strengthened. The business may also make a loss. In this case, the loss reduces company’s equity and in the worst case can push it into the red. During or after the financial year, the company's board must monitor the amount of equity and notify the Trade Register immediately if it notices that the equity is negative. Failure to do so may expose board members to personal liability for the company's debts.

What are the consequences of negative equity for the company?

When a negative equity declaration is added in the Trade Register, it becomes public. This means that banks, suppliers and other creditors can see the declaration. They actively monitor the data in the Trade Register. Negative equity can therefore reduce access to credit. In addition, negative equity may also lessen cooperation opportunities, as companies with negative equity are not accepted to public tender procurements. Fortunately, negative equity can be removed if the equity can be brought to at least zero. Of course, this situation may not be very sustainable from the company's point of view.

What can be done to turn negative equity into positive?

The first step is to find out what has caused the company to lose capital. For example, equity may have become negative as a result of poor profitability. Profitability can be improved by increasing sales and marketing, or by cutting costs.  Other possible measures include staff adjustments or the sale of inessential assets. In addition to these measures, additional capital can be raised for the company. Capital can be raised from external financiers, or from existing shareholders themselves. There are a number of different ways of developing equity, which are suitable for different situations. It is important to identify the reasons why equity has become negative.

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Summary:

  • The board of a limited company has a responsibility to report negative equity
  • Negative equity keeps a company from participating in public tender procurements and may reduce access to credit
  • Different ways to turn equity positive: profitability improvement, sale of assets, equity financing from shareholders or other providers of finance

 

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