What Is Contributed Capital?
Where does a company’s money come from? Well, one way for a company to accumulate money is to earn that money as part of its normal business operations. But when we talk about startups, we’re talking about companies that tend to collect a lot of money from another all-important source: investors. When an investor gives cash and other assets to a company in exchange for some of the company’s shares, their contribution is recorded in the shareholders’ equity section of that company’s balance sheet. Here it’s called, quite fittingly, contributed capital.
Contributed capital, also known as paid-in capital, reflects the total amount of capital shareholders have invested in a company. A shareholder’s ownership stake in the company is directly related to how much contributed capital she has, well, contributed. As a founder, it’s important to know how much shareholders have poured into your company and how their shares could dilute existing owners’ equity. We’ll get into all of that in this guide, but first let’s elaborate on our definition of contributed capital.
- What is contributed capital?
- What are the components of contributed capital?
- How do stock buybacks affect contributed capital?
- Get more out of your equity with Pulley
What is contributed capital?
Say a young and promising startup needs to raise a bunch of capital. Short of boosting its earned revenue in ways that might not be feasible, this startup has a few options.
One option involves taking on debt by borrowing money from a bank or lender. Another possible option involves issuing short-term debt instruments such as convertible notes, in which an investor essentially loans the startup money in exchange for future equity.
A third option—and the one that’s relevant here—is to raise capital from investors by issuing new shares of common stock or preferred stock.
Contributed capital is the total amount of capital shareholders contribute to a company in exchange for an ownership stake. You may also hear it referred to as paid-in capital, because it reflects the amount investors have “paid in” for their shares. This contrasts with earned capital (aka retained earnings), which reflects the amount a company has earned from its normal operations.
Where does contributed capital come from?
Depending on where a startup is in its fundraising journey, contributed capital may come from a number of different sources.
As a startup progresses through the various funding rounds (Series A, Series B, Series C, etc.), new investors typically come on board by contributing their capital in exchange for stock issuances.
If the startup later raises money through an initial public offering (IPO) or direct listing, this money will also be represented on the balance sheet as contributed capital.
Does contributed capital refer only to cash?
Contributed capital generally refers to cash, but in some cases investors can purchase stocks with non-cash assets, as well. These assets may include everything from fixed assets such as land and equipment to intangible assets such as copyrights and trade secrets.
Even these intangible assets make their way onto the company’s balance sheet and play a role in the valuation process. Their fair market value is calculated at the time of the deal, and this determines the amount they contribute to the company’s overall contributed capital.
What are the components of contributed capital?
On the stockholders’ equity section of the balance sheet, the reporting for contributed capital includes two separate accounts: the common stock account and the additional paid-in capital account.
The common stock account
The first account is the common stock account, also known as the share capital account. This account includes the par value of the stock. The par value is not intended to reflect the value of the stock on the open market, and it’s often is quite a bit lower. Investors typically pay a lot more money than the par value for their shares.
For example, an investor who contributes $25,000 in exchange for shares of common stock with a par value of $.001 will probably not end up with 25 million shares. Instead, that investor may end up with 5,000 shares, indicating that she was willing to pay a premium of $20,000 on the par value for her shares.
The additional paid-in capital account
The second account relevant to contributed capital is the additional paid-in capital account. This account captures the amount of money investors have contributed above the par value of the common stock. For the investor in the example above, the additional paid-in capital (i.e. the share premium) is $20,000.
When you add both of these accounts together, you get the sum total of contributed capital. If the example above were to encompass the entirety of a company’s contributed capital, the accounts would add up as follows:
- Common stock account: $5,000 (5,000 shares issued with a $1 par value)
- Additional paid-in capital account: $20,000 (the paid-in capital in excess of par value)
- Total value of contributed capital: $25,000 (common stock account + additional paid-in capital account
How do stock buybacks affect contributed capital?
Sometimes, a company may decide to repurchase its own shares from investors. This is known as a stock buyback, and you might think that it simply decreases the amount of contributed capital by whatever amount the company pays investors for their shares. Alas, it is not quite so simple.
When a company buys back its shares, the repurchased shares are reflected in the company’s balance sheet and financial statements as treasury stock. This stock’s value is typically determined by how much the company paid the investor in the exchange, rather than by the stock’s current market value.
Stock buybacks lower the amount of equity capital held by shareholders. But the existence of treasury stock ensures that buybacks do not affect the total amount of contributed capital for accounting purposes, as treasury stock is also accounted for as part of contributed capital.
Get more out of your equity with Pulley
Raising money from investors is an integral part of the startup journey, so it’s important to know how contributed capital works and how it’s calculated on your balance sheet. But, hey, we get it—you’re a founder, not a CPA. That’s why we’ve built out a full suite of equity tools to give you unprecedented visibility into your company’s cap table and overall equity picture.
Pulley’s equity management tools include everything you need to get more out of your equity, from fundraiser modeling to audit-ready 409A valuations. If you’re ready for a better solution, set up a demo with us today.