Capital Structure

A company can raise money in two main ways: by borrowing, through loans and bonds, or by selling ownership, through shares, and by keeping profits in the business. The proportions of each make up its capital structure.

For example, a company with 40 million of debt and 60 million of equity has a capital structure of 40% debt and 60% equity.

Debt has advantages. It is usually cheaper than equity, because lenders take less risk than owners, and in many countries interest is tax-deductible. Using debt also lets owners keep full control. But debt brings fixed interest and repayment obligations. If profits fall, a heavily indebted company may struggle to make payments and could face bankruptcy.

Equity is more flexible, because there are no compulsory payments, but it is more expensive and dilutes the ownership of existing shareholders. Companies look for a balance that keeps their overall cost of capital low without taking on too much financial risk. Stable businesses, such as utilities, often use more debt than young, unpredictable ones, such as technology start-ups.