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What is Legal Capital?

Legal capital is the minimum amount of equity a company must maintain to protect creditors and ensure financial stability. It's a safeguard, rooted in law, to ensure companies can meet obligations without excessive risk-taking. This concept is crucial for investor confidence and market integrity. How does legal capital impact your investments? Let's examine its role in corporate governance.
Osmand Vitez
Osmand Vitez

Legal capital is the value of a company’s outstanding equity shares. This value is maintained on the company’s accounting general ledger and is restricted from being used for dividends or other distributions. The amount of legal capital is based on the par value of the stock when it is issued on the open stock exchange. Par value has no relation to the actual market value of stock or the price changes of stock being bought and sold between investors. Legal capital and par value are basic items relating to equity investments.

Historically, stock markets were an unregulated industry and required a few basic standards for companies looking to issue stock among individuals and equity investors. The par value of stock was developed to ensure investors were not being sold company stock at different prices. When an initial public offering (IPO) was announced, companies had to declare the par value of its stock. This par value represented the minimum issuing price paid by investors; companies then recorded the total par value as legal capital on its accounting ledger. This allowed companies to maintain basic accounting values in unregulated securities markets for common stock.

Man climbing a rope
Man climbing a rope

Common stock tickets were printed and issued with par values listed for investments purposes. Equity investors could reasonably estimate the amount of legal capital a company had on its accounting ledgers by reviewing all issued stock tickets. This information would then be compared to the company’s financial statement to determine if any improprieties exist in the company’s equity balance.

Legal capital has largely become an archaic stock investment tool in today’s business world. Most common stock today is issued at par value of $.01 or with no par value at all. Common stock with no par value is allowed to have a set amount of legal capital set aside by the company’s board of directors or other management entity. This capital must remain on hand after all dividends or distributions are made to shareholders.

Most common stock IPOs do not have dividends attached to the stock purchases. Dividends are only paid out on preferred shares of stock. Par value for preferred shares is still important in today’s business market and must be declared by companies issuing preferred stock. Dividends may be calculated as a percentage of the total par value of the stock. The total par value of preferred stock must be reported as legal capital on the company’s balance sheet. Most companies must report preferred stock separate from the total common stock capital on financial statements.

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