Reserve fund: to create or not to create?

Capital companies were required to establish a reserve fund until 2013. Since then, it is (with the exceptions listed below) in principle up to them to decide whether they want to set up a fund, in what form and for what purpose. This does not apply only to companies that were established before the Companies Act came into force, which already had a fund and did not change their articles of association in connection with the amendment.

What is and what is the purpose of the reserve fund?

The reserve fund represents a certain financial reserve that a company can create to compensate for losses or to have funds in reserve for unexpected expenses.

The fund is usually made up of cash, but it is not a prerequisite. It may also consist in part of securities or other financial instruments.

If the founders decide to establish it, the memorandum of association should provide for its creation. The reverse is also true: the creation of a reserve fund is mandatory if the memorandum of association provides for it.

Use of the reserve fund

The reserve fund may be used to cover unexpected expenses or losses that may be incurred by the company. Its main purpose is to ensure the stability and financial resilience of the company in the event of unforeseen events or crisis situations. However, it can also be used to finance investments or development projects, or for distribution to shareholders in the form of dividends.

If the reserve fund is used to cover a loss, such use must be approved by the company’s general meeting.

In what types of companies is the fund used?

Reserve funds are found in various types of companies, whether they are small businesses, medium-sized or large corporations. However, it is typical for the large ones. As we mentioned, it is most commonly found in public limited companies, where it may even be mandatory to set one up.

Joint stock company

The creation of a reserve fund is possible from the difference between the price of the contribution in kind and the nominal or book value of the shares, provided that the articles of association or a resolution of the general meeting so determines.

As stated above, there is no general obligation under the Companies Act to establish a reserve fund. Nevertheless, there are certain situations in which a joint stock company is obliged to establish a special reserve fund. This is since, in layman’s terms, a company is considered profitable, or in more technical terms, if it acquires its own shares and reports them on an active balance sheet account. Retained earnings (or other funds) can be used to create it. If these treasury shares are disposed of again, the company can cancel or reduce the reserve fund.

Limited liability company

In a limited liability company, a reserve may be created from the difference between the valuation of the shareholder’s non-cash contribution and the amount of the shareholder’s contribution.

With the consent of the shareholder (or prospective shareholder), the reserve fund may be created from the difference between the valued value of the non-cash contribution and the amount of the shareholder’s contribution.

In this context, mention should also be made of the regulation of profit sharing in LLCs. The maximum amount that can be distributed is the sum of:

• the economic result for the last completed financial year,
• the retained profits from previous periods less losses from previous periods,
• allocations to reserve funds.

If the articles of association provide for the creation of funds from profits, the balance of such funds may not fall below the limit set by the articles of association.

How is the reserve fund created?

The reserve fund is created by a company regularly setting aside a portion of its profits in this fund. The exact amount to be set aside depends on the specific decision of the company, the minimum thresholds laid down by law or the conditions laid down in the articles of association.

Accounting and balance sheet

The reserve fund is part of the company’s equity and is recorded in the company’s accounts. It is shown on the liabilities side of the balance sheet under the heading ‘reserve fund’ or ‘other reserves’. The amount of the reserve fund is then regularly updated to reflect the actual state of the company’s financial reserves.

Use of the fund

Resources from the reserve fund may be used in various circumstances, in accordance with the company’s internal rules and legislative requirements. We have already outlined some of the uses in the introduction. Let us now look at them a little more closely:

1. Loss Coverage: the Reserve Fund serves as a backup source of funds to cover unexpected losses or extraordinary expenses. This can include, for example, emergency situations such as natural disasters, economic recessions or the loss of key customers.
2. Investments in development: The reserve fund can be used to finance investments in the company’s development, such as expanding production capacity, introducing new technologies or expanding into new markets.
3. Repayment of debts or liabilities: If necessary, the reserve fund can be used to repay the company’s debts or liabilities, which can reduce financial risk and improve the company’s creditworthiness.
4. Payment of dividends: In some cases, the reserve fund can be used to pay dividends to shareholders if the company’s profits are not sufficient to cover the amounts paid out.

The reserve fund is an important tool for managing the financial stability of a company. Its proper creation and management can help a company better deal with unforeseen events and ensure its long-term success.