In a context of economic crisis such as the current one, many companies are in the position of finding in their balance sheet a situation of negative net worth.
The Capital Companies Act states that any capital company that has its net worth reduced to less than half of the share capital shall be dissolved.
For this reason, it is necessary to be clear about what is the net worth, as well as the negative net worth of a Limited Company,what the consequences of negative net worth are and what to do when the net worth is negative.
Clarifying concepts: What is net worth?
The net worth of a company are all those elements that form the company’s own financing. In the balance sheet it implies the difference we get by subtracting the liability from the asset.
Digging a little deeper, let’s say that the asset is all those assets and rights of a company, acquired in the past and intended to make a profit in the future.
Liabilities,on the other hand, are the source of financing from which we have obtained the asset that appears in our balance sheet. When they are not own resources, they can be loans, debts and short- or long-term obligations. Liabilities directly affect the negative balance sheet of an undertaking.
So what is net worth? All the company’s own resources arising from the share capital contributed by the partners, the reserves held and the profits that the economic activity carried out by the company has generated.
Consequences of negative net worth
So,can the net worth be negative? The answer is yes, because this situation will occur when the accumulated losses are higher than the rest of the items that make up the net worth itself (share capital and reserves, preferably).
A simple explanation to arrive at this circumstance is that the money contributed by the partners (capital) and the saved profit of other years (the reserves), have been consumed due to the losses that the economic activity of the company has generated.
For all these reasons, it has been necessary to resort to indebtedness and the liability has increased. When this happens, we are faced with a negative balance sheet.
The consequence of this situation is serious. According to the Capital Companies Act, the negative net worth of a Limited Company causes the dissolution of the company, and the directors have the obligation to convene the General Meeting within two months so that the aforementioned dissolution is approved or the bankruptcy of creditors is promoted.
In this sense, it is necessary to point out that, in the event that the administrators do not comply with these guidelines, they will be liable in solidarity with the company.
They will therefore have to take over the company’s obligations. In addition, the liability for the same will take effect from the moment in which the cause of the dissolution took place.
This cause of dissolution, on the other hand, will not appear when the net worth is negative,but earlier.
The cause will be when the total accumulated losses cause the value of the net worth to be less than half of the share capital.
What to do when net worth is negative?
The solution to this state requires that the own funds have again the value required by the Capital Companies Law.
How to increase the net worth of a company? Achieving the entry of new funds into society.
Generally, it can be done in 2 different ways:
- With an increase in share capital.
- With a contribution from the partners to clean up the losses.
In both cases, the goal is to increase the company’s own funds and at the same time, reduce negative equity.
⇒ Assumption 1: Share capital increase
In the first case, the partners make a contribution in exchange for which they will receive shares in the company.
In this way, it is necessary to write and record this fact in the Register.
In some cases, it will be necessary to carry out what is known as “Operation Accordion”,in other words, to reduce and increase the capital simultaneously in order to economically clean up a society.
Thus, the company reduces its share capital to compensate for its indebtedness and clean up its negative balance sheet,but immediately afterwards it carries out the capital increase with which it attracts new resources and can continue with its normal activity.
⇒ Case 2: Contribution of partners to strengthen own funds
These voluntary contributions are not recovered, but they are made with the aim of refloating the company.
In this case, the operation is simple, since it is simply necessary an agreement of the Board of Partners that is reflected in the Minutes,without the need to register the fact.
In short, faced with the possibility that the company is in a situation of negative net worth, the two options are clear: close or contribute the necessary own funds to continue with the activity.
Before the definitive closure, we recommend that you seek the advice of
the accounting advisors of AYCE Laborytax
because their help can be key to favor its refloating.