Are you a new business owner? If so, there are probably entrepreneurship terms that leave you scratching your head. A capital contribution is one of them.
This contribution is money given to a business or partnership.
Sounds simple, right? But there’s a lot more involved in this contribution.
Are you interested in finding an investor? Before you sign, read the fine print before accepting a contribution. Continue reading this guide and understand how contributions work.
What Is a Capital Contribution?
A capital contribution is an act of giving money or assets to a company or organization.
When an investor or partner gives money for your business, this is called a contribution. But this differs from another form of contribution, such as a loan.
A capital contribution is usually given by an investor or someone who’s interested in partnering with your company.
Depending on the agreement, the capital doesn’t have to be paid back. But other contribution types require a debt from the business.
This investor or partner wants some form of control, called equity. When a third-party offer money, they desire some form of control or partnership over your enterprise.
There are other reasons why a third-party gives a company capital or money. These reasons include stock exchange.
When you submit your taxes, you report this capital as “paid-in capital.” This means this money was not received by a business operation, but are business funds as a result of equity.
Let’s discuss capital’s significance in these two areas.
What’s Equity?
Equity can have several different meanings, depending on the agreement between business owner and investor. Typically, equity refers to ownership.
Equity is usually expressed by subtracting the number of assets by the amount of liability. In this case, equity also represents a company’s value and worth.
Ownership can take a few different meanings. Some investors contribute their own capital to undertake a business under their wing. This means the investor takes on the business’ liabilities.
Or, the third-party can express ownership through stocks. In this situation, the third-party doesn’t have any liabilities with the company.
Two Types of Contributions
When you approach an investor for capital, they will usually order one of two contribution methods.
One method requires ownership or the investor taking a share of your profit. If you’re interested in an investment but are wary about a stake or ownership, then you will have to repay that amount.
Here’s more information regarding both forms of contribution:
Equity Investment
One of the most common contribution methods is the equity method. Like stated previously, equity is the ownership one of more people have over a company.
When an investor claims equity, they have a share of the profits and losses of your business. Higher equity stakes involve the investor taking your company under their wing to maximize profit.
Your investor will help sculpt a business plan that will use their capital. This includes business expansion, reducing debt, building liquidity, and hiring new staff.
This brings more capital into your company, so the investor receives an ROI.
Some investors use this money for stock ownership. In this instance, they have low equity. They take a share of your stocks but don’t have a say over the profits and losses of your company.
Debt Investment
Are you uneasy by the thought of someone running your business? No problem — utilize a debt investment. This investment is similar to a traditional loan. A private investor will loan you capital, but you will have to pay it off.
You can pay this off with the capital your business generates. Or you pay it off in interest.
Other Types of Capital
Capital doesn’t have to be expressed as money. There are plenty of non-cash advances that signify a stake or loan for the company. This is defined a non-cash asset. A non-cash asset can include buildings and machinery.
But the two types of investment still apply.
If your investor wants equity in your company, they will use the non-cash asset to improve your business’ structure. This can include a new office or updated equipment.
If you decide on a debt investment, the investor will buy you the property and equipment.
For property, you may make rent payments to the investor. For machinery, you’ll pay off the amount by the duration of the equipment’s life cycle.
Owner’s Contribution
What if you don’t want a middle-man or any loans? You can use owner’s contribution. This is capital you contribute to your own company.
Capital could mean money you transfer to your business from your personal account. You can also buy property or equipment using your own funds.
Owner’s contribution is beneficial if you run a partnership. If you contribute a certain amount, your ownership increases over your partner’s.
Keep in mind, any amount of the contribution that you take out decreases your owner’s equity.
Why You Should Accept a Contribution
Capital is essential to the growth of your business. Whether you’re using capital as money or a non-cash asset, a contribution can greatly help your business.
Even if you’re submitting your own contribution, your personal funds can be the ticket for business growth.
If you accept an equity investment, you have no obligation to pay the money back.
Rather, your investor will use their skill to grow your business and maximize your capital. And if you accept a debt investment, the stakes are usually more lenient then if you go through a bank.
Your Business Will Grow with More Capital
When an investor gives your business capital, this is called a capital contribution. But this capital always comes at a price. An investor will have a stake in your company, either through business ownership or stock ownership.
Or, you can choose the pay back the investor the same you would a lender. If you have the personal finances, you can make an owner’s contribution and increase the equity you have on your company.
Did an agreement fall through between you and your investor? Request an appointment with a business lawyer.
