Is Paid-In Capital More Important to an Investor?

Is Paid-In Capital More Important to an Investor?
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Paid-in capital, also called contributed capital, is the money invested by stockholders when they buy shares of stock directly from a company in a private sale. This money represents funding that has been raised through equity in the business, as opposed to earned capital, which is money raised by operations, such as through selling a product or service. Paid-in capital is listed on the company balance sheet, but its importance to investors depends on the goals of the investor.

Types of Paid-in Capital

There are two main types of paid-in capital. One is stated capital, which is the company's stated value of any shares that have been issued for private sale. The stated value is also called the par value – and this value is set by the company. Additional paid-in capital is money that investors have paid for stock over and above the par value. For example, if company A offers to sell 10,000 shares of stock at $2 per share – the stated capital is $20,000. If a private investor actually pays $3 a share for the stock, then the additional paid-in capital is $10,000. A high additional capital amount may signal that investors have a lot of confidence in the company.

Public Offering

The stated paid-in capital, or par value, does not tell investors very much about what price the stock will fetch in a public offering. This is because the company can place any figure it wants on the stated paid-in capital. In a public offering, potential public investors will instead look at the value of the additional paid-in capital. This is shown on the company's balance sheet. If the additional paid-in value is high, this is a signal that the company may be headed for strong growth and profits and the stock may be a good buy. In this case, the price may rise well beyond the par value at the initial public offering.

Private Equity Funds

Paid-in capital has another meaning in the world of private equity funds. In private equity, money that is invested in a private equity fund is called committed capital. This money may not be invested immediately. Instead, it sits in a fund and can be drawn on, or drawn down, if needed. When the general partner identifies a good investment, he notifies the other partners in the fund that he will be drawing down the amount of committed capital to pay for the investment. In this case, paid-in capital is a measure of the amount of the committed capital that has been drawn down, or invested. The amount of paid-in capital can indicate to private equity investors the health of a private equity fund and how active the fund is.

Paid-in vs Earned Capital

Earned capital is a measure of how much profit a company has made. Earned capital that is reinvested, instead of being paid as dividends to shareholders, is called retained earnings. When investors decide whether or not to invest in an ongoing business, they will examine the company's levels of debt, earned capital and paid-in capital. A lot of debt but little paid-in capital may indicate that a company has little cushion to weather a downturn. A small amount of paid-in capital may also indicate that the owners have not invested a lot of their own money, or have not found many private investors with confidence in the company, and this could signal that the company is not a good investment.