Financing your company is a crucial part of its growth and stability. There are four generally recognised options for transferring funds and assets to a company. The choice depends on the purpose of the funds, the needs of the company, and the financial and legal status of the company. In this article, we introduce different ways for owners to transfer funds to the company, along with options for attracting new investors. Each option results in legal and/or tax consequences, so it is important to carefully choose the most suitable option for your company.
Let’s take a look at the owner’s options for financing the company. There are many reasons why owners may need to inject additional funds into their company, besides the initial share capital. However, paying the registered share capital is always the first step when the company requires financing. Before exploring the options below, it is advisable to check the share capital status in the e-Business Register. If the record shows Capital is €2,500 – Established without making a contribution, we recommend proceeding with the capital payment and registration. Once that is complete, but additional financing is still needed, you can consider the following options.
1. Loan
Providing a loan to your company is the most common way of financing. An individual can offer an interest-free loan to their company, though charging interest is advisable to extract tax-free money from the company. If the owner is a legal entity, interest must be charged. To avoid tax issues, interest should be set at market levels.
For individuals giving loans with interest:
- Income tax will be withheld from interest earned by Estonian residents.
- Non-residents must pay income tax on the interest in their country of residence.
Hence, it’s not entirely “tax-free money”. If the owner is an Estonian company, interest must be charged. If the owner is a foreign entity, whether interest-free loans are permitted depends on the laws of the parent company’s country. If the interest exceeds market rates (according to Eesti Pank statistics), income and social tax may apply. The loan agreement between the owner and the company must be in writing, specifying at least the loan amount, duration, and interest rate (if any). This written agreement is essential for recording the loan in the company’s balance sheet.
Advantages:
- No registration with authorities required.
- Corporate income tax free distribution of interest
Disadvantages:
- Increases obligations of the company in the balance sheet, which may result in equity that does not comply with the legal requirement at the end of financial year.
A loan is suitable when the company is active, requires financing, and has sufficient revenue to repay both the loan and any interest.
2. Increasing Share Capital (Monetary or Non-Monetary)
2.1. Increasing Share Capital with Nominal Value
Capital increase must be registered in the business register and new capital is valid from registration. Registering capital increase in the business register requires resolution of the shareholders, amendment of the articles of association, transferring assets to the company and submitting the petition to the business register. Additionally, it must be declared in the TSD (many mistakenly think that registration in the commercial register automatically means it has been declared for tax purposes – these are separate processes).
Owners can increase capital by making monetary contributions into the company’s IBAN account or through non-monetary contributions, such as transferring assets or converting an owner’s loan into share capital.
Advantages:
- Payments into the capital can later be returned to the owner tax-free.
- Affects the equity not liabilities as the loan would affect.
Disadvantages:
- requires following certain legal and tax processes, including audit review for capital above 25 000 EUR
- increases the limit of mandatory equity
2.2. Capital Increase with Share Premium
A share premium occurs when the owner pays the nominal value, which is registered as share capital, plus an additional amount that is recorded in the equity. Both contributions and payouts must be declared in the TSD.
Advantages:
- Increases the mandatory equity limit only minimally in cases where larger financing is required.
Disadvantages:
- Share premium can only be used to cover losses or increase share capital.
- Contributions into and distributions from equity must be reported to tax office
A capital increase is a suitable funding option if the company’s revenue does not allow repayment of a loan and interest, or if the company needs to increase equity to the legal limit. Money paid into the capital can later be paid out tax-free.
3. Voluntary Reserves
Owners may decide to set up voluntary reserves, and to establish the conditions for making contributions to and payments from such reserves.
Setting up voluntary reserves must be included in the articles of association. Voluntary reserves may be created only after registering the appropriate articles of association in the business register.
Payments to and from the reserves are made on the basis of shareholder’s resolution. No interest may be charged on the contributions made to the voluntary reserves.
Contributions to voluntary reserves must be registered in the tax office.
Advantages:
- More flexible compared to capital contributions.
Disadvantages:
- requires certain legal paperwork compared to other options
- contribution into and distribution from reserves must be reported to tax office
Voluntary reserve is suitable in case you do not want to increase the share capital or when company is not able to repay loan and interest.
You could also put the funds to voluntary reserves, to use the reserves based on the needs. Money put into the reserves will be paid out tax free.
4. Investor Solutions
Both loans and capital increases are appropriate for gathering financing from investors. An initial loan from an investor can be later converted into shares, or you can bypass the loan stage and issue shares directly in exchange for the necessary funding. Note that transactions involving share issuance or sale are notarial deeds. Until the registration in the commercial register is completed, any loan is treated as a liability.
Another option for attracting investors is selling part of your shares to an investor. This is also a notarial transaction. Keep in mind that, according to Estonian law, a share in a private limited company is considered joint property between spouses. Therefore, if you choose to sell your share, your spouse’s approval is required.
1Office can assist you with the legal and tax compliance related to these options.