What is Capital Contribution Agreement?
A capital contribution agreement is a contractual agreement among business owners and investors that is commonly executed for business partnerships and joint venture arrangements. A capital contribution agreement generally outlines the contributions of capital into a business (e.g., cash, services, intellectual property, know-how, a lease, or even an additional business), any ownership units received in return for such contributions, the value of each type of contribution, and the manner of and time for making such contributions. The importance of properly defining the contributions in an agreement is underscored by the business implications if the parties later disagree (either at the time of the contribution or upon a future liquidity event) as to the nature , extent or value of a contribution made or to be made at a future date.
A capital contribution agreement may be a stand-alone agreement, one of the few agreements in a related transaction or an ancillary agreement to an underlying transaction document. For example, a contribution agreement for the purchase of a business may be a stand-alone agreement, while the same contribution agreement may be an ancillary agreement to the purchase agreement, providing a mechanism for adjusting the purchase price over time as the parties realize the value of the assets contributed to the business.
Key Components of a Capital Contribution Agreement
The capital contribution agreement should contain basic information about the parties involved, the amount of the contribution, the allocation of the ownership interest and any special status the owners may have. All of these components set out the information that will later serve as the basis for the company’s operating agreement.
The parties to the capital contribution agreement are typically the initial owners or members of the business. If the business was formed in a jurisdiction that does not use the term "member" then the initial parties may be referred to as initial owners or shareholders. Regardless of the specific nomenclature used by a particular jurisdiction, these terms are interchangeable. The capital contribution agreement should also contain contact information for all of the parties to make possible future communication. Some parties may wish to keep their contribution confidential. In such cases, the capital contribution agreement would exclude contact information for those owners. Depending on how the structure of the business is set up, the capital contribution agreement will be the basis for proving ownership in a future dispute. It should contain the appropriate personal identifying information for those parties including their address, state of residence or domicile and social security number or employer identifier number (EIN). If an owner is a business organization, the type of entity should be identified. Any special status the owners may have should be noted. For example, if any of the owners are disabled veterans they must show proof of that status to use the Veterans Administration’s "Vets First!" program offered free using the same healthcare system given to the VA.
The amount of capital contribution should set out the nature of the capital contributed, e.g., land, equipment, intangible property. Property contributed to the business in exchange for shares or a percentage of ownership is known as a "capital contribution." If more than one type of property was contributed to the business, then each type should be listed along with any monetary value assigned to the property by the parties. In some states, the laws provide that the contribution of a business entity by one of the members shall be considered to be dividends under certain circumstances.
Although it is typical for the parties to agree on how much ownership interest they will have in the company or any particular piece of property owned by the business, the amount agreed upon may have tax consequences. Special allocations of company property or assets are sometimes based on the concept of "convinced worth" since it is not always necessary for members to agree on the specific dollar value of property owned to agree on how the gains or losses from that property will be shared. Whether an asset has "appreciated" or "depreciated" is not as important as the member’s ability to communicate about the property to agree on what is worth. Thus, a handshake that communicates each person’s view about the property is viewed as a "real and economic consensus concerning the worth" of that property. The parties to the capital contribution agreement do not need to know the specific details (cost basis, fair market value) of the property they own together, only the "arithmetic formula" they will use in deciding what they own.
Benefits of Utilizing a Template
A well-constructed template, created by a skilled business lawyer, helps businesses effectively communicate their expectations to their members. Using this type of tool in business relationships tends to result in fewer misunderstandings and more positive outcomes, particularly when used for capital contributions. Because such agreements can be complex and may result in members needing to invest considerable sums of money into a business, it’s important for businesses to have a clear, consistent, concise, and comprehensive capital contribution agreement template.
Some of the most significant advantages of a capital contribution agreement template include:
Consistency – When all members of a business agree to the same terms outlined in a capital contribution agreement, it establishes a clear baseline within the business. This way, each member knows how much they’re expected to contribute, when to contribute it, how it should be contributed, and what the consequences are if they fail to do so. The template is also advantageous because it typically covers multiple types of capital contributions so that all potential situations are addressed.
Ease of Use – Templates are much easier to use than developing a new document from scratch, especially when the same capital contribution agreement is issued to multiple members. The process of drafting the agreement is streamlined, as all parties receive the same capital contribution documents.
Time Saving – Businesses save time when they create and use templates, as it prevents them from having to meet one-on-one with every owner/partner to draft individual capital contribution agreements. There’s no need to schedule meeting times, take detailed notes, and repeat information multiple times. Instead of having to contact each owner/partner individually with the necessary details, these written agreements can be distributed quickly and efficiently.
Modifying Your Capital Contribution Agreement Template
Customizing an agreement template is essential to ensure that it is appropriate for your business. Although there are numerous agreements available online, it is paramount to ensure that you choose the language that best suits your individual situation. Generally speaking, if you have a capital contribution agreement template, then you should review it with competent counsel to ensure that it is suitable to your individual business and pertinent industry.
The first step is to analyze every paragraph of the agreement template. Look for information that only applies to certain businesses or industries. For example, certain industries like the cannabis industry have stricter requirements that need to be adhered to. A Capital Contribution Agreement for a cannabis company may contain additional paragraphs that might not be relevant for other companies.
Second, analyze the information for applicability to your company. For example, your company may have different limitations on shareholder contributions or additional requirements for shareholder contributions. It is important to customize your agreements as to the specific formalities that your company may require.
Third, ensure that any additional terms that your company may need are included in the template. For example, consider whether restrictions on shareholder contributions would be applicable to your company’s capital contribution agreement.
Finally, ensure that all the conditions apply to the specific business and industry that your company operates in. Be sure to review it with competent counsel who will be able to identify restrictions, terminologies, and any regulatory concerns you may have.
Common Errors to Evade
Even if you’re familiar with capital contribution agreement templates, it’s surprisingly easy to make mistakes during the drafting process. It’s vital that you take the time to familiarize yourself with the various components of a capital contribution agreement before you attempt to prepare a draft. That said, some of the most common mistakes associated with capital contribution agreements include: Ignoring the laws in your state or country: A capital contribution agreement that isn’t tailored to the laws of the state (or country) in which the partnership is operating simply won’t hold up when challenged in court. Conducting surface-level research: The more thorough your research is , the better prepared you’ll be for unexpected developments down the line. Take your time and make sure you’re engaging in deep research. Using online templates that contain errors: If you’re using an online template, make sure it’s of the highest quality. To ensure this is the case, look for a template that’s been thoroughly prepared and edited and do not simply accept the first one you find. Forgetting to add flexibility: No matter how well a capital contribution agreement is written, it’s almost guaranteed that some problems will arise after it’s completed. Be sure to leave room for potential adjustments down the line so minor issues can be resolved with minimal stress.
Legal Implications and Issues around Capital Contribution Agreements
When creating a capital contribution agreement template, legal considerations must be kept in mind. In particular, the terms of the agreement should comply with the requirements of capital contributions under the respective business formation laws of the jurisdictions in which the business is formed and operates. For example, under partnership laws in most states, capital contributions can be in the form of money, services or the transfer of other assets to the partnership. Oregon Revised Statute 67.555; Idaho Code § 30-24-25. Under the Delaware Limited Liability Company Act, a member may contribute cash, property, services rendered or a promissory note of other obligation to the LLC in exchange for limited liability company interests. Del. Code Ann. tit. 6, §18-702. Subsidiary corporations are subject to different legal regime, therefore, state laws governing corporations must be reviewed in connection with the terms of the capital contributions. Sec. of State Div. of Corporations & Commercial Code 1, at 1930-1932 (Del. 2013); Uniform Limited Partnership Act § 106(g) (17 Pa. Stat. Ann. § 106(g)); Mich. Comp. Laws §§ 450.1403(1), 450.1501.
In addition the business entity structuring the agreement template should consider whether it is subject to Securities and Exchange Commission (SEC) registration requirements with respect to the capital contributions. The SEC exempts the offering of securities to partners, officers and directors from the registration requirement, subject to certain conditions. 17 C.F.R. §230.506(b)(1)(iv). The SEC also exempts offerings of securities that are limited in scope to exempt from protection under the Securities Act of 1933 (the "1933 Act"). 15 U.S.C. §§77d, 77z-4; 17 C.F.R. §230.501. Because the terms of the capital contributions (e.g., the entity’s anticipated financial needs, the amount or type of capital contributions sought, the number of investors targeted and how the capital contributions would affect the terms of the business’ capitalization) and structure or timing of the capital contributions may have an impact on these exemptions, legal counsel should be sought to ensure compliance with the 1933 Act.
Sample Template To Follow
A sample capital contribution agreement template is generally a tailored document specific to the interests, investments and agreements of the parties involved with respect to a particular company. The following is an overview of a generic template structure and commonly used clauses that could be utilized in a capital contribution agreement.
Glossary
The first section includes a glossary of defined terms and key terms that will be referenced throughout the agreement. Frequently used terms are:
Recitals
This section identifies the parties to the agreement, including their roles and sometimes, the contributions being made by each.
Representations and Warranties
Every party to the agreement makes certain standard representations and warranties , including:
Payments and Contributions
The next section allocates ownership among members and details who will hold equity in the LLC and how much they will contribute to the formation and any additional funding deemed necessary by members or investors. This section details how and at what times the contributions will be paid out, as well as the consequences for failure to make contributions.
Distributions
This section explains how distributions will be made and at what times.
Amendments
This clause provides the process and vote required for the capital contribution agreement to be amended. Generally, members must agree unanimously or by a three-fourths vote to amend the capital contribution agreement.