Ad­di­tion­al capital con­tri­bu­tions: De­f­i­n­i­tion and ex­pla­na­tion

A limited liability company’s assets and an unlimited company’s assets involve capital provided by its share­hold­ers. However, under certain cir­cum­stances, ad­di­tion­al capital deposits may be required. The oblig­a­tion to make a sup­ple­men­tary payment is set out, where ap­pro­pri­ate, in a company’s operating agreement.

Like a limited company, the limited liability company has share capital provided by all of its share­hold­ers pro-rata. The same applies to a private limited company (LTD). An investor will make a capital con­tri­bu­tion as set out in an operating agreement. Members agree to make payments to the company at the rate and time specified in the agreement. But sometimes an LLC may require urgent cash to stay afloat or finance an ac­qui­si­tion. To cover these costs, LLC operating agree­ments will often include a clause on ad­di­tion­al capital con­tri­bu­tions. When a company requires ad­di­tion­al funding, it may issue a capital call.

There are initial and ad­di­tion­al capital con­tri­bu­tions. LLC owners can usually secure initial capital con­tri­bu­tions in the following ways:

• Equity in­vest­ment: When a person or business invests money into your LLC in the form of equity, they will usually receive a stake in your business in return. It is often a preferred type of initial capital in­vest­ment because LLC owners will not be required to pay back the money whether their business succeeds or not. At the same time, the addition of a qualified investor may also add a knowl­edge­able partner to the business.
• Debt in­vest­ment: Debt in­vest­ments are es­sen­tial­ly loans. Investors and business owners will usually agree on an interest rate and time frame during which they will be required to pay back any in­vest­ments made.
• Con­vert­ible debt in­vest­ment: Con­vert­ible debt in­vest­ments are a com­bi­na­tion of equity and debt in­vest­ments. LLC owners can accept a loan in­vest­ment that can later be converted to an equity stake in the company.

Failure to make an initial capital con­tri­bu­tion could result in a penalty or for­fei­ture of a share­hold­er’s stake in the LLC. However, whether the share­hold­er loses their share in a business or not will depend on the stip­u­la­tions set out in the original agreement. There’s usually also a grace period during which share­hold­ers can make con­tri­bu­tions.

If the de­fault­ing share­hold­er has pre­vi­ous­ly taken over their share of the business from someone else, then the legal pre­de­ces­sor is liable for the out­stand­ing amount. However, they may purchase the share in the business against the amount owed.

An operating agreement may contain a clause which stip­u­lates that share­hold­ers con­tribute ad­di­tion­al capital to meet un­ex­pect­ed demand for cash. Cases where funding may be required un­ex­pect­ed­ly include tax payments, paying off debt or paying for repairs. The agreement may contain a set per­cent­age of capital or variable amounts. There may also be a cap on the amount of capital a company can request from share­hold­ers. It’s important that prospec­tive share­hold­ers check their re­spon­si­bil­i­ties in regard to ad­di­tion­al con­tri­bu­tions before entering into an agreement.

The need for ad­di­tion­al funding is usually decided by the decision-makers or members board. If the majority vote for ad­di­tion­al capital con­tri­bu­tions, a capital call can be initiated.

In many cases, the operating agreement will grant share­hold­ers a set amount of time to respond to a capital call. If a share­hold­er fails to make the ad­di­tion­al in­vest­ment, there could be drastic con­se­quences. Investors could be expelled from the LLC and their share in the company may be diluted. The latter is referred to as “squeeze-down”. The freed-up shares can then be dis­trib­uted among other members.

To prevent loss of funding (or in the worst case the collapse of the company), agree­ments often allow other members to loan the money another share­hold­er is unable to provide. The loan is then repaid at an agreed interest rate. The share­hold­er who failed to respond to the capital call will be penalized.

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