There are a number of ways that an organization or business can secure capital to run or to expand. Many choose to raise capital by offering stock to the public. Some organizations, however, choose to offer memberships as a way to raise operating expenses. When the members' equity shows as a deficit on the financial statement for the year, it is often a good indication that the organization is in financial trouble.
Membership
Equity membership is the preferred organizational structure for a number of businesses or organizations. Private clubs, for example, may offer equity memberships. Condominium associations and cooperatives also frequently offer them.
An equity membership, for the purpose of financial structure, is not the same as a simple membership to an organization that requires you to pay monthly or annual dues. An equity membership makes you an owner in the business or organization.
As an equity member, you have a stake in the success or failure of a company. Unlike paying dues, when you are an equity member, you are entitled to your equity back if you choose to cancel your membership. In the meantime, the company has the use of your money in return for privileges, discounts or services as a rule.
As a general rule, a members' equity deficit is not a good sign for a company's financial health
Financial Statements
All companies that have equity members are required to prepare financial statements each year much like a publicly traded company that offers stock to investors. The financial statement must be made available to the members. It tells them what their money was used for during the year and gives an overall picture of the company's financial health.
Equity Deficit
While a financial statement may include a considerable amount of information, the balance sheet is the most important part for a member to look at each year. At its most basic, adds the company's liabilities to the amount held in members' equity to arrive at the company's asset amount.
Looked at from another angle, the assets held by the company minus the outstanding liabilities equals the members' equity.
For example, if a company has $100,000 in assets and $40,000 in liabilities then the members' equity equals $60,000. If, however, the company owes its members $80,000 in equity, then it is operating with a members' equity deficit.
Considerations
When members' equity shows as a deficit, this means that if all the members were to request their equity back at that point in time, the company would not have the money to pay everyone.
As a general rule, a members' equity deficit is not a good sign for a company's financial health. If you are concerned about a members' equity deficit, consult with your tax professional to determine whether you should withdraw your equity or keep it where it is.
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