The Act defines “paid-in capital” as the sum of (1) cash and other consideration received, less expenses, including commissions paid or incurred by the corporation in connection with the issuance of its shares; plus (2) cash and other consideration contributed to the corporation by or on behalf of its shareholders; plus (3) amounts transferred to paid-in capital by action of the board of directors or shareholders pursuant to a share dividend, share split, or otherwise; and minus (4) reductions in paid-in capital as provided elsewhere in the Act.
Paid-in capital is generally determined by adding the corporation’s capital account and its paid-in surplus accounts set forth in the equity section of a corporation’s balance sheet. For example, if a newly formed domestic corporation issues 100 common shares having a par value of $1 per share for a consideration of $1,000, the corporation’s paid-in capital account would be $1,000, consisting of the sum of the corporation’s capital account of $100 (100 shares × $1 par value) plus the corporation’s paid-in surplus account of $900 (the consideration received for the shares upon issuance less the par value of such shares). Increases in paid-in capital can result from the issuance of additional shares or the contribution of additional capital to the corporation without the issuance of shares or as a result of amounts added to paid-in capital by action of a corporation’s board of directors or shareholders pursuant to a share dividend or share split.
A corporation may reduce its paid-in capital in a number of ways. The board of directors may reduce paid-in capital by: (1) acquiring and cancelling shares to the extent of the cost of the reacquired and cancelled shares or such lesser amount as may be elected by the corporation; (2) the amount of dividends paid on preferred shares; or (3) the amount of any liquidating dividends. Paid-in capital can also be reduced pursuant to a bankruptcy reorganization plan. However, paid-in capital can never be reduced to an amount that is less than the aggregate par value of all issued shares having a par value.
A reduction in paid-in capital may also occur as a result of a merger between a parent and subsidiary corporation. In the case of such a “vertical” merger, the paid-in capital of a subsidiary may be eliminated if either (1) it was created, totally funded, or wholly owned by the parent corporation; or (2) the amount of the parent’s investment in the subsidiary was equal to or exceeded the subsidiary’s paid-in capital. Finally, a corporation may reduce its paid-in capital by reacquiring its own shares. Reacquired shares, however, constitute treasury shares until cancelled on the records of the Secretary of State.
All increases and reductions to paid-in capital are required to be reported to the Illinois Secretary of State, and are not effective until reported, regardless of when the increase of reduction occurred.
Why bother keeping track of paid-in capital at all? There can be penalties for failure to timely report increases to the Secretary of State. Assume that the board of directors of a corporation decides it must obtain an audited financial statement, whether because its lender requires an audit or because the corporation will be sold. During the audit, the auditors note that the paid-in capital as reported to the Illinois Secretary of State is not the same as the paid-in capital on the corporation’s balance sheet. The auditor advises the board that in this particular case the two paid-in capital amounts should be the same. As a result, the corporation is required to report the increase in paid-in capital, but because the increases took place several years prior, substantial penalties are due by the corporation for failure to report increases in a timely manner.
Please do not hesitate to contact us if you have any questions regarding your corporation’s calculation or reporting of its paid-in capital.