Legal capital

Legal capital is that amount of a company's equity that cannot legally be allowed to leave the business; it cannot be distributed through a dividend or any other means. It is the par value of common stock and the stated value of the preferred stock that a business has sold or otherwise issued to investors. The legal capital concept does not apply to any stock that is authorized for issuance but which has not yet been issued.

The original intent of legal capital was to create a reserve that could be accessed by a company's creditors in the event of default. However, the concept is effectively negated for those businesses issuing stock having extremely low par values. For example, if a company issues a share of common stock at a par value of $0.01 per share (an extremely common par value), this means that only $0.01 of the amount for which the share is sold must be reserved as legal capital, while all other receipts are credited to the additional paid-in capital account. Thus, even an issuance of 1 million shares would only yield legal capital of $10,000, assuming a par value per share of $0.01. In this example, the company issuing the 1 million shares could issue a dividend to its investors in the amount of the additional paid-in capital associated with the sale, but could not issue a dividend for the $10,000 designated as the par value (i.e., legal capital) of the stock.

Some states do not require any par value, which means that companies incorporating in those states have no legal capital requirement at all.

Related Terms

Legal capital is also known as stated capital.

Related Courses

The Balance Sheet