Shareholder's Capital vs. Shareholder's Loan

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Introduction

As a new business owner, most likely you'll be required to pump money into your business from your personal savings or you may opt to take up a personal loan for the initial financing of your business.

Even if you receive funding support from friends and family or an angel investor, it is highly encouraged that you also invest some money into the business. When applying for future small business loans, the owner's stake in the business will give a boost of confidence to the respective bank looking to approve the loan. 

IMPORTANT NOTE: For Private Limited / Sendirian Berhad businesses, you are advised to refer to your company's secretary as required under Section 171 of the Companies Act Singapore and the Malaysia Companies Act 1965 (‘MCA’) when setting up your shareholder structure and the injection of your initial capital.

Differences between Capital and Loan

Shareholder's Capital is equity financing while Shareholder's Loan is debt financing. Both have its own pros and cons but ultimately, it is up to the business owner to decide which is best for the business.

Shareholder's Capital: Unlike loans, capital is recorded under the equity account instead of a liability. The amount of capital invested into the business translates into shares that will be distributed to the owners accordingly. 

Screenshot taken from Financio 

More often than not, a business owner will not be able to withdraw the initial capital made. Instead, a business owner will be entitled to dividend payouts. Alternatively, a business owner may also choose to sell its existing shares to another individual. 

Shareholder's Loan: A shareholder's loan on the other hand is recorded as a long-term / non-current liability for a business. It should be treated like any other debt. When issuing a loan, it is best to have an attorney draw up the terms of the loan, including repayment and consequences for non-repayment of the loan. It should be made clear that the loan issued to the business is part of its binding obligation.

Screenshot taken from Financio

Additional Consideration:

1. Are you the only contributor for the initial capital - If there are multiple parties involved in the supporting for the start-up funds, taking the route of shareholder's capital will also mean issuing stakes of the business to all the members involved. A business owner should be careful not to issue beyond 49% of the company's stake to avoid losing majority ownership.
2. Are you able to meet to requirements of loan repayment - Unlike paying out dividends to stakeholders, the repayment of a loan is mandatory as with any other debt obligations. This requirement may be challenging for a start-up that has yet to find a firm financial footing.