Debt capitalization in Latvia: common reasons and practical steps

What is debt capitalization?

Debt capitalization (a debt-to-equity conversion) is a transaction where a company replaces an existing liability towards a creditor - often a shareholder or another related party - with equity. In practice, the company cancels (derecognizes) the loan payable and, in return, issues shares or increases the creditor’s ownership stake. Depending on the approved terms, the amount may be split between nominal share capital and share premium.

In Latvia, a common implementation is a share capital increase funded by a contribution in kind, where the contribution is the creditor’s receivable against the company (a claim arising from a loan agreement). Receivables are treated as intangible property rights, which can be contributed under the Commercial Law framework, provided that valuation and filing requirements are met.

When does it make sense?

Most businesses consider capitalization when shareholder/related-party loans become material and start affecting how the company looks to banks, investors, partners or auditors. It is also a practical choice when the loan is, in substance, long-term support and there is no realistic plan to repay it in cash soon.

Common triggers:

• rapid growth funded by shareholder loans while equity lags behind;
• a bank financing process where leverage ratios or minimum equity requirements matter;
• preparation for investment, M&A or due diligence where a clear capital structure is expected;
• large related-party interest accruals increasing documentation and tax exposure;
• the need to protect working capital and reduce repayment pressure.

5 common reasons to convert debt into equity

1) Improve balance sheet metrics and perceived resilience

Loans are liabilities. If shareholder loans are large, the company may look highly leveraged even if the funding is supportive. Debt-to-equity conversion reduces liabilities and increases equity, improving common indicators (equity ratio, leverage, coverage). This can materially change how external stakeholders assess risk.

2) Support bank financing and investor confidence

Banks and investors care about the risk profile of funding. A loan can theoretically be called back, creating liquidity risk. Equity, by contrast, is structurally long-term. Capitalization demonstrates commitment and often makes the company’s funding story more convincing.

3) Reduce exposure linked to related-party interest and transfer pricing

Where the lender is a related party, interest rates and other terms should be consistent with market conditions. If interest is material, transfer pricing documentation (or at least a robust interest-rate rationale) may be required. By converting part of the loan into equity, the company can reduce future interest expense and shrink the scope of related-party financing that needs ongoing support.

4) Preserve liquidity and strengthen working capital

Repaying shareholder loans consumes cash. If the business needs liquidity for operations or growth, capitalization allows balance-sheet improvement without immediate cash outflow. This is particularly useful when the loan is effectively long-term financing.

5) Simplify governance and reporting

Multiple loans with different maturity dates, interest clauses and repayment schedules can complicate accounting and management reporting. Converting a portion into equity can simplify the structure and reduce administrative overhead.

How it is typically done in Latvia (high-level steps for an SIA)

A standard approach is a share capital increase funded by a contribution in kind (the receivable). The Register of Enterprises provides practical guidance on required forms and attachments, including valuation/board statement requirements in common situations.

1. Adopt a shareholders’ resolution to increase share capital and approve the terms (amount, deadlines, subscription and payment method).
2. Define the payment method clearly: contribution in kind (the receivable/claim) or cash contribution (if the money is paid after the decision).
3. Prepare the valuation / board statement (or obtain an independent valuation when required) consistent with the contribution type and thresholds.
4. Obtain the creditor’s written consent to contribute the receivable and attach support (loan agreement, balance calculation).
5. File the application and attachments with the Register of Enterprises to register share capital changes.
6. After registration, record accounting entries to derecognize the liability and recognize the increase in equity (share capital and, where applicable, share premium).

Accounting entries

The exact accounts depend on the chart of accounts used, but the economics are consistent: liabilities decrease, equity increases. Illustration (EUR 30,000 converted):

• Dr  Shareholder loan payable (liability) - 30,000
• Cr  Share capital (nominal) + Share premium (if applicable) - 30,000

If interest has accrued, confirm whether it is included in the contributed claim (and documented) or settled separately. Capitalization does not automatically eliminate accrued interest unless it is explicitly part of the converted receivable.

Key tax and compliance checks

• Related-party loans: can you support the interest rate and terms as market-based?
• Transfer pricing: is documentation required or advisable given the scale and counterparties?
• Consistency: do corporate documents, filings, bank statements and accounting entries align in timing and narrative?
• Substance: is the rationale genuine (capital structure) rather than an attempt to disguise profit distribution?
• If the creditor is an individual: do you understand when capital gains taxation becomes relevant (typically upon disposal of shares)?

References:

• Commercial Law (Komerclikums)
• Civil Law (Civillikums) - receivables as intangible property
• Register of Enterprises: SIA share capital increase (practical guidance)
• Register of Enterprises: valuation of contributions in kind (SIA)
• Register of Enterprises: set-off note (ieskaits)
• Accounting Law (Grāmatvedības likums)
• Cabinet regulation: Accounting record-keeping rules
• Annual Reports and Consolidated Annual Reports Law
• Corporate Income Tax Law
• Cabinet Regulation No. 802 - transfer pricing documentation
• SRS (VID): Transfer pricing documentation material
• SRS (VID): Capital gains tax (useful when shares are sold)

Last updated 2026, February 18th