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CarolineHughes
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JamesMillar, post: 28338 wrote:
You can book it as either debt or equity – both have their pros and cons. It really depends on your business profile, where its going etc etc.

Booking as debt can be handy to simplify repayment of funds on a tax friendly basis but it can also easily lead to “technical” insolvency. Without adequate equity (so if its booked as debt) the net assets of the company can easily lapse in negative territory. Your debt may be uncalled (with open terms) but all it takes is one other minor creditor to have a go at you when you have negative net assets and all of a sudden you have exposure as a director under the Corps Act. I’ve seen companies trip up on this before.

Booking as equity helps reduce the risk of directors liability for insolvent trading but it leads to problems in returning those funds. Equity is pretty much a one way ticket (unless you undertake a share buy back which has different tax issues).

Sometimes a balance works well but again – it completely depends on your business profile and attributes (and where it is going). For example we would not participate / invest in a startup that booked founders funds as debt unless it has exceptional financial characteritics from early on (high profits and strong net assets / balance sheet). It would need to be converted to equity first (but often as redeemable pref shares).

These concepts may seem a little beyond your business right now but at least you will have an idea of the issues when you encounter them in the future.

Hi James, love the detail, thanks for this. I have a much clearer picture now and can see the pros and cons of both. As the startup funds are minimal (I have high hopes for early earnings!) perhaps the equity option is best, so as not to leave the business in the negative position. What is the journal entry for this? Thanks, Caroline