What is capital reduction? About capital reduction in an entrepreneurial company, private limited company and public limited company

Capital reduction in an entrepreneurial company – what and why?

A capital reduction is a reduction of the share capital by a certain amount. The capital reduction must have a purpose before it can be realised. The purpose may either be to use the amount of the reduction to cover any loss, for distribution to the shareholders, for transfer to the free reserves or in connection with an amortisation provided for in the articles of association. This article reviews what it means to make a capital reduction in an entrepreneurial company, private limited company and limited company. Who is empowered to do this and how this can be done in practice?

Who has the decision-making power?

It is the company’s general meeting (i.e. the shareholders who can attend and vote at the general meeting) that has the decision-making authority in connection with a capital reduction. Subsequently, such a decision requires an amendment majority, i.e. with a 2/3 majority, at a general meeting. However, it is also important to keep in mind that the principle of equality (pursuant to section 45 of the Danish Companies Act) is still complied with. This is because the mutual legal position of the shareholders must not be disturbed, unless this has been adopted by a stricter qualified majority, i.e. by a 9/10 majority. The general meeting has the decision-making power, unless the general meeting authorises the company’s board of directors and/or executive management to make decisions to this effect, when the exact amount of the reduction is stated at the same time.

In order for a decision to be made on a capital reduction in an entrepreneurial company, private limited company and public limited company, there must be a purpose for the reduction. This should be seen in the light of the different forms of application of the reduction amount, which are discussed in the next section.

Coverage of losses

Coverage of losses relates to the situation where the company fails to sell its products and experiences a loss. Where a loss in excess of the free reserves has been identified, the capital reduction may be made for the purpose of covering that shortfall. In this case, there is only a change in the financial statements in the company’s accounts. More precisely, it is the items share capital and loss that are reduced as a result of moving a sum of capital from the share capital to the loss item. This means that the equity is not affected and thus not reduced. This is important to take note of, as such a capital reduction does not require a summons of creditors. In addition, an auditor’s statement is also not a requirement. However, it should be noted that it is the management’s responsibility to assess whether an auditor’s statement or other professional assessment should nevertheless be obtained. It is crucial here that the amount of the reduction does not exceed the company’s carry-forward loss on the date of the capital reduction itself. Please note that the Danish Business Authority may require documentation for this.

Distribution to shareholders

Capital reduction can also be made with a view to pleasing the capital owners, as the reduction amount can be distributed to the capital owners, or initially transferred to free reserves, which can later be distributed. In connection with a capital reduction in the form of a distribution, there is a creditor protection consideration, as opposed to when the company simply covers the loss by making reclassifications. The reason for this consideration is, among other things, that the creditors have an expectation of the company’s liquidity situation at the time of entering into the agreement with the company. Therefore, it is generally not in the interest of the creditors that the share capital is reduced in such a way that the shares are cancelled and thus cease to exist.

In the case of distribution, the equity is reduced, which affects the creditors. Therefore, the company’s creditors must be invited to report their claims to the company. The creditors then have a maturity of 4 weeks to file their claims. Therefore, the company must wait 4 weeks to complete a possible capital distribution. Once the creditors have notified their claims for maturity and these have been paid, the company has 2 weeks to report the capital reduction to the Danish Business Authority.

Amortisation by statute

The articles of association may contain a provision according to which the shareholders are obliged to have their shares redeemed in connection with a capital reduction. An amortisation is then made by the shareholders having to return their shares in return for payment for these. The situation can be equated with the company’s purchase of its own shares, which is thus also equated with a capital reduction.

When the share enters the company, it has no value, as the share ceases to exist because the company already owns the property. Equity therefore decreases with the value of the share in the event of buy-backs. The equity stake can therefore be said to represent value for the shareholders alone.

Regardless of the reason for the capital reduction, keep in mind that the management can potentially incur liability for damages. So make sure to seek professional advice on this.

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