Equity

Equity is the capital that owners and investors make available to the company permanently. It does not have to be repaid on a schedule and bears losses. In return, equity providers expect a say and a share in the company's value. For growth companies, it is often the basis for product development and new markets. At the same time, every round dilutes the shares of the existing shareholders. A clear capital strategy therefore combines equity with sensible debt capital.

How equity is composed

On the balance sheet of a GmbH (German limited liability company), equity appears on the liabilities side, structured under the German Commercial Code (Handelsgesetzbuch, HGB). It comprises the subscribed capital, that is, the share capital (Stammkapital) according to the commercial register, the capital reserve, the revenue reserves, the profit carried forward or loss carried forward and the result of the current year. Arithmetically, equity is always assets minus debts.

An example with freely chosen round figures. A GmbH has EUR 25,000 of share capital. An investor pays EUR 2,000,000 for 20% of the shares. Of this, only EUR 6,250 flows into subscribed capital as new shares, which then amounts to EUR 31,250. The remaining EUR 1,993,750 goes into the capital reserve. If losses of EUR 400,000 from previous years are added, equity amounts to EUR 1,625,000.

What this means in practice

Equity is the company's buffer. It absorbs losses before banks, suppliers or employees are affected. Lenders therefore look at the equity ratio, that is, equity divided by total assets. With total assets of EUR 2,500,000, that would be about 65% in the example.

A good picture is recognised by equity growing from the company's own strength over several years and by it being documented who owns which share. A weak picture shows when every financing merely plugs holes or when losses grow faster than contributions.

If more than half of the share capital has been used up by losses, the management must convene the shareholders' meeting under the German Limited Liability Companies Act (GmbHG). If equity is arithmetically negative, the question of over-indebtedness arises. Deadlines and personal liability depend on it, which is why tax adviser and lawyer belong at the table early here.

Common mistakes

• Equity is confused with the bank balance, although a company can report a lot of equity and still have too little money in its account.
• Every gap is closed with a new round, although a loan or a funding programme would have served the same purpose without diluting shares.
• The shareholding overview is not maintained, so that convertible loans and promised employee shares only come to light at the investor.
• Contributions are transferred informally or offset against consideration, which can make the contribution ineffective.

Frequently asked questions

What is the difference between equity and share capital?

Share capital is a fixed figure in the articles of association and in the commercial register, at least EUR 25,000 for a GmbH. Equity is the actual figure from the balance sheet and changes with every profit, every loss and every contribution. Share capital is therefore only one component of equity.

How high should the equity ratio be?

There is no generally valid figure, because values differ widely by sector and business model. A software house is assessed differently from a business with its own production. What makes sense is a comparison with the company's own sector over several years.

What happens if equity becomes negative?

Negative equity means that debts exceed assets. In itself that is not yet a ground for insolvency, because the going-concern forecast matters, as does whether shareholders step in. The assessment is, however, tied to deadlines, and the management is personally liable if it reacts too late.

The Roemer Capital view

The equity ratio alone says little. What interests Roemer Capital is its direction over three years and what has sustained it. Equity from retained profits is a different signal from equity from the last round. If shareholder loans appear as equity in the presentation, this stands out in the review and raises the question of what else was calculated generously.