Definition: Minimum legal capital is the amount of assets that shareholders are required to contribute to a corporation by law. In other words, many states have laws that require shareholders to invest a minimum amount of assets in the company at all times. The minimum levels are usually based on the par value of the stock .
For example, some states that require companies to contribute assets worth two times their par value shares. A corporation with 1,000 outstanding $2 par shares would be required to invest at least $4,000 of assets. Keep in mind that this refers to the amount of assets that are initially contributed to the corporation in exchange for shares. If the company loses money year over year, the shareholders are not required to fund the operations to maintain this amount of assets.
These laws are intended to protect creditors from shareholders thinly capitalizing the company and taking out huge amounts of debt or distributing all of the company assets and declaring bankruptcy. Since corporate shareholders are protected with limited liability , creditors can’t come after them personally in case of a default. If creditors aren’t paid back, they can only sue the company for its assets. Thus, many states require that company keep a certain amount of assets for creditors.
What Does Minimum Legal Capital Mean?
Because of these minimum capitalization laws, business owners and managers have reasons to create no-par value stock in the corporate charter or keep the par value as low as possible. Since no-par value stock doesn’t have a stated value on it, the state law doesn’t apply. This means the company can issue shares to new investors at any price without having to worry about going below the minimum capitalization threshold.