Key Takeaways:
- Capital accounts track each investor’s equity balance inside the LLC, separate from any actual bank account.
- Capital accounts start at zero and change with contributions, distributions, taxable income, and taxable losses, providing the accounting backbone for investor allocations.
- Distributions reduce an investor’s capital account when treated as a return of capital, lowering their remaining equity balance over time.
- Capital accounts should “true up” to zero at the end of the deal, meaning final liquidating distributions should fully close out investor and company capital accounts.
- Preferred return tracking often requires a separate preferred balance account, especially when accruals and payment timing don’t match.
Transcript
What “Capital Account” Means in Syndication and Fund Documents
One term you oftentimes see in private equity funds documentation, or in documentation for syndications is a term called capital account. So what exactly is a capital account? And how do you use it?
My name is Tilden Moschetti. I am a syndication attorney with the Moschetti Syndication Law Group. One of the things I really enjoy most about my job… is working with things in finance.
Capital Accounts Are Accounting Buckets—Not Bank Accounts
Capital obviously means money, so it means cash. These are the cash accounts that we use in order to manipulate things in our accounts. We don’t mean bank accounts.
When we talk about capital accounts, we’re talking about accounts as it relates to accounting. An account is just a grouping of funds that we can keep track of.
Sometimes you’ll hear accountants talk about a chart of accounts… a list of different accounts… like budget items. For accounting purposes, we talk about them as accounts.
Each Investor Has Their Own Capital Account
A capital account is that cash that’s set aside for a specific person. Each investor has a capital account, so we keep track.
If an investor invests $100,000, we log $100,000 in their capital account. That’s their initial contribution, that is their initial capital account.
How Capital Accounts Increase and Decrease Over Time
That money can go up or it can go down based on different things that take place.
If we make a distribution as a return of money, that can reduce the amount of their capital account. We still oftentimes call it the initial capital account, even though it’s not initial anymore, but it’s reduced that amount of cash that they have as pure equity in their accounts.
Key Takeaways From the Video
Capital accounts are those accounts that keep track of the capital in the LLC.
They always start at zero and are adjusted through contributions, distributions, taxable income, and taxable losses.
Both the company’s capital accounts and the investors’ capital accounts need to end at zero. Your final distribution at the very end should be zero.
Capital accounts are oftentimes very confusing, especially in that first year and if you have different distribution periods for each investor. Some investors like to only get distributions annually, some get them quarterly.
I also keep track of a preferred balance account, which is an account that keeps track of any monies that they’ve made that they should be receiving because of a preferred return, but haven’t received yet.
Cash contributions, cash distributions, reporting taxable income, and reporting taxable losses all impact the capital accounts.
Closing: Why Capital Accounts Matter for Compliance and Investor Trust
My name is Tilden Moschetti. I’m a syndication attorney with the Moschetti Syndication Law Group. We can help you stay in compliance with the SEC, make sure that everything’s right, and keep your investors happy. All those things start with a good legal framework.