What is negative equity?
Equity (item 10/15) is what remains when you subtract debts and provisions from everything the company owns. It consists of contributions or capital, reserves and profit or loss carried forward.
When a company makes a loss, it goes into item 14 (loss carried forward) and reduces equity. If accumulated losses exceed contributions and reserves combined, equity turns negative: debts then exceed everything the company owns.
Example: a fictitious caterer
A fictitious caterer has €180,000 of assets: kitchen equipment, a delivery van, stock and money in the bank. Against that stand €205,000 of debts: €90,000 of long-term loans and €115,000 owed to suppliers, tax authorities and staff. Equity is therefore -€25,000.
- Everything the company owns
- Debt due after one year
- Debt due within one year
This did not happen in one year. Equity fell from €40,000 to below zero in four years, because the caterer made a loss every year.
What it means, and what it does not
- It is not bankruptcy. Under Belgian law a company is bankrupt when it has persistently stopped paying and its creditworthiness is shaken. As long as bills are paid, a company with negative equity can keep operating.
- It is a sign that the buffer is gone. New losses are borne directly by creditors.
- Context matters. A young company that is investing and still has start-up losses is different from a company that has been losing money for years. Sometimes there are owner loans that are subordinated to other debts.
- For companies, the law attaches a procedure to it: the alarm bell procedure.
The alarm bell procedure
The Belgian Code of Companies and Associations (WVV/CSA) requires the board to inform shareholders and let them decide when net assets become too low. Net assets are close to equity; the law prescribes a few adjustments for the calculation.
BV/SRL (article 5:153)
When net assets are at risk of becoming negative or have become negative, the board must convene the general meeting.
- within two months after the board established this or should have established it
- the meeting decides on dissolution or on measures to ensure continuity
- the board justifies its proposals in a special report
- the same applies if it is no longer certain that the company can pay its debts over the next twelve months
NV/SA (article 7:228)
When net assets have fallen below half of the share capital, the board of directors must convene the general meeting.
- within two months after the finding
- the meeting deliberates on dissolution and possibly on other measures
- the board justifies its proposals in a special report
- if net assets fall below a quarter of the capital, dissolution can be decided by a quarter of the votes (article 7:229)
If the board does not follow the procedure, it can be held liable: the law presumes that damage suffered by third parties results from that failure, unless proven otherwise.
This page gives general information about the law and is not legal or tax advice. The exact rules and exceptions are in the Code of Companies and Associations. If this applies to you, discuss it with an accountant, company auditor or lawyer.
How does equity become positive again?
In annual accounts you mainly see these movements:
- Making a profit: every euro of profit kept in the company reduces the loss carried forward.
- A new contribution or capital increase by existing or new shareholders.
- Converting debt into equity, for example a shareholder loan that is contributed.
- A creditor waiving a debt, which is booked as income.