Financing of a limited liability company

Financing refers to all sources of money that a company can use to fund its operations, such as purchasing raw materials or equipment and paying employee salaries.

Typically, financing is needed the most at the beginning of a business, before revenue or profit begins to accumulate.

In an ideal situation, a company’s business operations are profitable, allowing it to cover all future operating expenses with previously earned profits and still retain some reserves. However, profits do not always accumulate, and financing may be needed for a longer period even after the business has started.

Financing is an extremely essential part of a limited liability company’s operations, and the regulations concerning financing form a subject area that every shareholder should understand.

Standard loan to a limited liability company

Administratively, the lightest and easiest way to finance a company when your business temporarily and quickly needs money for example, to pay invoices is to provide a standard loan.

It is advisable to prepare a loan agreement that specifies at least the parties to the loan, the loan amount, the repayment period, and any applicable interest.

It is also recommended that the board of directors approve the acceptance of the loan in meeting minutes, although a board decision is not legally required. Nevertheless, a board resolution is recommended for good governance and transparency.

Interest paid on the loan is considered capital income for the lender.

SVOP Fund as an Investment Option

A shareholder or another party may make an investment into the SVOP fund (the invested unrestricted equity fund). Most often, the investment is made by a company shareholder.

An SVOP investment does not bear interest. It may be with consideration, for example if new shares are issued in a share issue, or without consideration, meaning the investor does not receive shares or any other compensation from the company.

The SVOP fund is part of the company’s unrestricted equity. It is recommended that an agreement be made between the investor and the company regarding the SVOP investment. In addition, the company’s board of directors must decide on the matter.

Distribution of funds from the SVOP fund is decided by the general meeting of shareholders based on a proposal from the board. The investment can only be returned if the conditions for dividend distribution are met.

Entries may also be made to the SVOP fund in connection with corporate restructurings, company formation, or share issues. For this reason, it is important to clearly record the entries separately in the accounting records.

As a general rule, distributions from the SVOP fund are taxed as dividends, making them taxable income for the recipient.

However, if the recipient can provide reliable evidence that the funds are returned from an investment they made no more than ten years earlier, the capital repayment from a non-listed company may be taxed under capital gains rules instead. In this case, the recipient typically does not incur immediate tax consequences. The unrecovered acquisition cost of the original SVOP investment can be deducted when calculating the gain, meaning the repayment is effectively tax-neutral.

If you make an investment into the SVOP fund, it is advisable to prepare a separate agreement. In addition to the investment agreement, a board resolution is also required for accepting the SVOP investment.

Subordinated loan as a source of financing

A subordinated loan may be provided either by a shareholder or by another party.

A written agreement must always be prepared between the parties, specifying matters such as repayment terms and the interest on the loan. The acceptance of a subordinated loan also always requires a board resolution.

For tax purposes, a subordinated loan is considered debt, even though it has some characteristics similar to equity. Repayment of the loan principal and payment of interest occur in accordance with the loan terms and within the limits of distributable unrestricted equity.

Interest paid on a subordinated loan is a tax-deductible expense for the company, and it is taxed as capital income for the recipient.

Key differences between an SVOP investment and a subordinated loan

One of the most significant differences between an SVOP investment and a subordinated loan concerns the order of repayment if the company is dissolved or goes bankrupt.

A subordinated loan has lower priority than other creditors, but higher priority than share capital. An SVOP investment, however, is treated similarly to share capital, meaning it is repaid last as equity.

Another important difference is that a subordinated loan is essentially earmarked money that is repaid to the lender according to the repayment terms when distributable funds allow.

By contrast, funds distributed from the SVOP fund benefit all shareholders in proportion to their share ownership, unless otherwise specified in the company’s articles of association. For this reason, an SVOP investment is often the simplest solution in companies with only one shareholder.

It is also possible to record an entry in the SVOP fund when equity is increased by converting a subordinated loan or other receivable into an equity investment. This allows equity to be strengthened through internal balance sheet arrangements.

In such a case, it should be noted that when a subordinated loan is converted into an equity investment, the financier’s status changes from creditor to equity investor. Additionally, as noted above, the converted amount will likely benefit all shareholders when it is eventually returned.

Increasing equity

Both financing methods can be used to improve the company’s solvency in general or in situations where lenders require an increase in equity as a condition for granting a new loan.

An investment can also be made using either method if there is a need to increase equity to avoid liquidation proceedings.

Although a subordinated loan is recorded as liabilities on the balance sheet, it may be added back to equity for calculation purposes when assessing whether the company has lost its equity and whether there is a registration obligation. However, this does not increase the equity recorded on the balance sheet.

Impact of financing forms on net assets

The choice of financing method also affects the company’s net assets, and therefore its ability to pay dividends.

A subordinated loan, like other loans, generally reduces the company’s net assets, which in turn affects dividend distribution possibilities.

The SVOP fund, however, is included in net assets, and an increase in net assets also increases the amount of more lightly taxed dividends that can be distributed.