There may be a negative balance in the stockholders' equity line item in the balance sheet. If so, this means that a company has incurred losses of such size that they completely offset the combined amount of any payments made to the company for its stock by investors, and any accumulated earnings from prior periods.
Negative stockholders' equity is a strong indicator of impending bankruptcy, and so is considered a major warning flag for a loan officer or credit analyst. However, it can also mean that a business is in the ramp-up stage, and has used a large amount of funds to create products and infrastructure that will later yield profits.
Negative stockholders' equity is particularly common in the following situations:
- Intangibles amortization. A company has acquired another entity, and then amortizes the intangible assets recorded as part of the acquisition. This amortization can be an extremely large amount that overwhelms the existing balance in stockholders' equity.
- Debt funding. A company has had one or more periods of massive losses that more than offset the balance in stockholders' equity, and management has chosen to fund the losses with debt (a liability) rather than by selling more stock (which would have increased the balance in stockholders' equity).
- Accrued liabilities. A company has accrued extremely large provisions for liabilities that have not yet occurred (such as environmental remediation). This creates a loss that can offset the balance in stockholders' equity, while not yet requiring an offsetting cash infusion.
- Dividend. A company's board of directors has elected to issue a substantial part (or all) of its stockholders' equity to investors as a dividend. This can be a preliminary step to the orderly liquidation of a business.
Negative stockholders' equity does not usually mean that shareholders owe money to the business. Under the corporate structure, shareholders are only liable for the amount of funds that they invest in a business.
If a company reporting negative stockholders' equity were to liquidate, its stockholders would probably receive nothing in exchange for their original investments in the company's stock, though this depends on how much the company can earn by selling its remaining assets and settling any remaining liabilities.
Negative stockholders' equity is also known as negative shareholder equity.