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, not only is working with the law and working with great clients, but I also get to work on things in finance. Finance is another one of my passions; I love studying it. I read finance books, even accounting books, because the two go hand in hand.

So one topic that oftentimes comes up, and I get to talk about more than ever to my clients, is what does this term “capital accounts” mean? For example, a lot of times we talk about an initial capital account for your members or for your investors. What is that? Or what are these other accounts that are getting set up? What is a capital account anyway?

Let’s break it down. 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. That’s an account specifically in a bank. 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, which can be a list of different accounts. You might think of it as a budget item, like you have your mortgage on your budget item. Or you think about groceries, things like that are parts of your budget. For accounting purposes, we talk about them as accounts. It’s that pool of money that’s set aside or segregated for a specific purpose.

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. Now 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.

I hope that’s been helpful. But let’s talk about some key takeaways before we leave for today:

  1. Capital accounts are those accounts that keep track of the capital in the LLC.
  2. They always start at zero and are adjusted through contributions, distributions, taxable income, and taxable losses.
  3. 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.
  4. 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.
  5. 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.
  6. Cash contributions, cash distributions, reporting taxable income, and reporting taxable losses all impact the capital accounts.

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. That’s what we’re here for – to make sure that we help you be successful as a syndicator or a private equity fund manager.