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What is a company’s equity capital?

Qu’est-ce que les fonds propres d’une entreprise ?

Today, many SMEs with sales of less than 50 million do not have enough equity capital. However, equity is a guarantee of confidence for banks, a reserve for financing your projects and security in the event of a financial crisis. Equity is one of the criteria used to analyse whether your company is solvent, in particular by calculating the level of equity in relation to financial debts.

In this article, you will find the definition of equity capital for a company, as well as its importance and how to obtain and analyse it.

1. What is the definition of equity capital for a company?

Definition of equity capital

Your equity (also known as “shareholders’ equity”) is capital incorporated directly into your company’s liabilities. It represents all your resources and is an indicator of the financial value of your company. Equity capital is transferred by your shareholders or is also generated by your company’s profits. So each year, when your company draws up its profit balance sheet, it gives part of it to the shareholders and the other part is kept to strengthen your equity capital, in particular to be able to invest in the future.

Composition of shareholders' equity

Equity capital is calculated as follows:

  • Your share capital: the capital contributions made by your shareholders and partners when you set up your business.
  • Your net profit for the year: this corresponds to all the gains and losses during your accounting period.
  • Your reserves: the profits accumulated during your previous accounting periods and not distributed in the form of dividends can be summarised as follows: some reserves are compulsory (legal reserves) and others are optional (statutory reserves).
  • Your retained earnings: these represent accumulated profits that are not distributed in the form of dividends. After the reserve has been replenished, the profits can be transferred to retained earnings.

Where are they placed on the balance sheet?

Your equity is shown on the liabilities side of your balance sheet. It is made up as follows: firstly, shareholders’ equity (capital, reserves, retained earnings, etc.) and secondly, other equity, which does not apply to all companies (share issues, conditional advances from the government, etc.).

2. What are the advantages for your company of having equity capital?

The benefits of equity capital for your company

  • First of all, it finances your business, especially when it is starting up, thanks in particular to equity capital. This helps to support the first few years of the business if, at the outset, it does not generate sufficient cash flow.
  • It also provides security for third parties. A substantial amount provides a guarantee for investors or suppliers… It gives your business legitimacy.
  • What’s more, the more equity your company has, the less it will have to borrow, and the better it will be able to cope in times of crisis.
  • Equity capital also makes it easier to take out a bank loan. It gives a good indication of the company’s solvency. It can also be the basis for calculating your borrowing capacity.The more equity your company has, the greater its creditworthiness.
  • Finally, it can be redistributed to shareholders (dividends) if it is positive.

The risks of not having enough equity capital

  • Firstly, bank loans are more difficult, and sometimes impossible, to obtain for your business.
  • Secondly, your business may not be able to continue. You may have to file for bankruptcy.

3. How can you increase your company's equity capital?

The different ways of increasing your equity

  • The first and most “natural” way is to make profits and keep them to invest.
  • Beyond that, it is possible to raise funds by bringing in new shareholders. These new partners can be close friends or family (“love money”, generally up to €50,000), or you can bring in a business angel (up to €1,000,000), who will also help you by supporting you.
  • You can also call on investment funds (more than €1,000,000), before turning to the financial markets (stock market flotation, for example).

Why increase your equity capital?

This could enable you to finance the growth of your business in the future. If bank loans and grants are not possible because you are going through a development phase involving a change of business model or expansion into new markets, you can consider increasing your equity by raising funds. This will enable you to raise debt from banks or specialist debt funds at the same time. This leverage will ensure that you have the funds you need for your development plan.

How do you go about it?

Calling on investors can be complex. If you have any questions, we can help you put together a solid project.

4. How do you analyse your company's equity capital?

By analysing your equity, you can determine whether it is positive or negative.

Negative equity is equity that is less than half your share capital. This means that your company is in financial difficulty. This is not very reassuring for creditors. A general meeting must therefore be called to reconstitute the equity.

If your equity is above half your share capital, it is positive. It is an indication of your financial strength, even if it is not an absolute guarantee of it.

 

In conclusion, equity is a partial reflection of a company’s financial health. So it’s vital to consolidate your equity properly and make the right decisions about it. If you would like an expert opinion on your equity capital, we would be delighted to help you.

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