When a foreign investor puts money into a Kenyan company, one of the first structuring questions is how that money goes in. It can be subscribed as share capital, lent to the company through shareholder loans, or split between the two. The choice affects control, how and when the money can come back out, the tax cost of extracting returns, and the balance of power with any Kenyan partner. This article compares the two routes under Kenyan law.
Share capital: permanent money with votes attached
Money subscribed for shares becomes part of the company’s share capital. It buys ownership and, for ordinary shares, votes in proportion to the holding. Under the Companies Act, 2015, an ordinary resolution needs a simple majority (section 256) and a special resolution needs not less than seventy-five percent (section 257). The size of each shareholder’s stake therefore decides who controls which decisions.
Share capital is hard to get back. A company may make a distribution, including a dividend, only out of profits available for the purpose: broadly, accumulated realised profits less accumulated realised losses (section 486). A loss-making restaurant in its first years cannot pay dividends, however much cash it holds. Returning capital itself requires a formal reduction of share capital, by special resolution (section 407). A private company may support the reduction with a solvency statement instead of applying to court (section 419). Either way, it is a procedure, not a bank transfer.
On a winding up, shareholders rank after every creditor. Share capital is the first money lost if the business fails.
Shareholder loans: repayable money without votes
A shareholder loan is a debt owed by the company to the shareholder. It carries no votes. Its terms are whatever the loan agreement says: amount, interest rate, repayment schedule, events of default and whether it is secured. Repayment of a loan is not a distribution, so it is not limited to distributable profits. A company that is cash-positive but has accumulated losses can still repay a loan on its terms, provided it remains able to pay its debts.
A secured shareholder loan ranks ahead of unsecured creditors on an insolvency, and an unsecured one ranks alongside other unsecured creditors, in both cases ahead of share capital. For an investor funding a restaurant fit-out, that priority is valuable. Banks lending to the company, however, will usually ask shareholders to subordinate their loans, so negotiate this early.
The tax differences
Dividends are paid out of after-tax profits, so the company gets no deduction for them. They attract withholding tax when paid to shareholders, and the rate for a non-resident depends on the Income Tax Act and any applicable double taxation treaty. Our article on dividend repatriation and withholding tax explains how this works.
Interest on a shareholder loan is, in principle, a deductible business expense for the company, but there are limits. Under section 16(2)(j) of the Income Tax Act, gross interest paid or payable to a non-resident is not deductible to the extent that it exceeds thirty percent of the borrower’s earnings before interest, taxes, depreciation and amortisation in the year. The restriction covers interest on all loans, payments economically equivalent to interest and the costs of raising the finance. It does not apply to certain categories, including micro and small enterprises registered under the Micro and Small Enterprises Act, which may matter for a single-outlet restaurant. Interest paid to a non-resident lender also attracts withholding tax, again subject to any treaty.
The practical effect is that a modest, documented shareholder loan at a commercial rate can be tax-efficient, while a heavily loan-funded company with thin earnings will lose part of its interest deduction. Model both before deciding.
Control and your Kenyan partner
The funding mix changes the balance with a local partner. Suppose a foreign investor funds the entire fit-out and a Kenyan partner contributes premises and management for a thirty percent stake. If the investor’s money goes in as share capital at the same price per share, the investor’s holding will reflect that, and the partner’s stake will be diluted unless the partner is given shares for their contribution. If most of the money goes in as a loan, the investor can agree a smaller shareholding while still protecting the investment as a creditor.
Shareholders have a statutory right of pre-emption on new share issues (section 338), so future capital calls must be planned for. If the partner cannot or will not put in their share of new capital, the shareholder agreement should say whether they are diluted, whether the investor may lend instead, and on what terms.
Whatever the mix, record it in the shareholder agreement: how much each party contributes, in what form, the loan terms, whether loans must be repaid before any dividend, and what happens to the loans if a shareholder leaves. Our article on buying out a joint venture partner shows why loan treatment matters at exit.
A sensible default
For a small or medium foreign-owned business in Kenya, a common structure is enough share capital to meet the company’s regulatory and banking needs and to support any immigration application, with the balance advanced as a documented shareholder loan. Our article on Class G investor permits explains how the immigration authorities assess the investment. The right split depends on the business plan, the tax position of the investors and the deal with any local partner.
Where the capital comes from a development finance institution or private equity fund, the corporate and regulatory steps are set out in our legal checklist for DFI and private equity raises.
How We Can Help
Clay & Associates Advocates advises foreign investors on funding structures for Kenyan companies, drafts shareholder loan agreements and shareholder agreements, and coordinates with tax advisers on the withholding tax and interest deduction position. If you are setting up a hospitality business, our guide to opening a restaurant in Kenya as a foreign investor covers the wider set-up. Contact our corporate and commercial team before you transfer funds.
Sources: Companies Act, 2015, sections 256, 257, 338, 407, 419 and 486; Income Tax Act, section 16(2)(j).
Frequently asked questions
Can a Kenyan company repay a shareholder loan if it has made losses?
Yes, if the loan terms allow and the company can still pay its debts. Loan repayment is not a distribution, so the distributable profits test in section 486 of the Companies Act does not apply to it.
Is interest on a shareholder loan tax-deductible?
Generally yes, but interest paid to a non-resident above thirty percent of EBITDA is disallowed under section 16(2)(j) of the Income Tax Act, unless the borrower falls within an exempt category. Withholding tax also applies to interest paid to non-residents.
Does a shareholder loan give me votes?
No. Votes come from shares. If you need control as well as protection, combine an appropriate shareholding with reserved matters in the shareholder agreement.
Should shareholder loans be secured?
Security improves your ranking on an insolvency, but lenders to the company may require subordination. Decide this with your partner and any bank at the outset, and document it.
Need advice on your own matter?
Tell us what you are dealing with. You will know what it involves and what it costs before you commit.
This article is general information on Kenyan law as at its publication date, not legal advice. Reading it does not create an advocate and client relationship.
