Capital Structure
Capital structure is the mix of debt and equity that funds a company's assets — senior loans, junior and mezzanine debt, preferred and ordinary shares — and the order in which those claims are paid. It sets the cost of capital, the risk the equity bears and the room to grow; a buy-out rewrites it in a day, and for a bank or a licensed fintech the regulator has already written the lower bound.
- Also known as
- Capital stack, Funding structure, Debt-to-equity mix
- Used at
- every financing decision, every acquisition (the buyer's structure and the target's), every valuation (the discount rate), and the lender's covenants
- Binding
- yes, in the instruments — loan agreements, intercreditor deeds, share classes — and, for regulated firms, in capital rules that set minimum equity against risk
- Typical measures
- net debt to EBITDA (leverage), debt to equity, interest cover; for banks, capital ratios against risk-weighted assets
- Typical trade-off
- debt is cheaper than equity (interest is deductible and lenders bear less risk) until leverage makes the equity riskier and the debt dearer; the optimum is where the total cost is lowest and the covenants survive a bad year
- Parties
- the shareholders, each class of lender, the board that sets the policy, and the regulator where there is one
How capital structure works in practice
A company with €100m of assets can fund them with €100m of equity, or €60m of debt and €40m of equity, or any mix the lenders and the shareholders will accept. More debt raises the return on the equity when things go well — the same profit spread over less equity — and the risk of losing it when they do not, because interest is owed whatever the profit. The lenders price that risk: the first €30m of debt is cheap and senior; the next €20m is dearer and junior; beyond that, only mezzanine lenders and equity. The board's job is to find the mix that keeps the cost of capital low without making a bad year fatal.
Acquisitions are where structures change fastest. A private equity buyer replaces a founder's all-equity company with 50–60% debt overnight; a strategic buyer funds a deal with its own debt and inherits the target's. The intercreditor agreement then ranks every claim — senior first, then mezzanine, then vendor notes, then preferred equity, then ordinary — and the ranking is what decides who is paid in a restructuring.
For a licensed fintech the structure has a floor the board did not choose: regulatory capital that must be equity, held in the regulated entity, unavailable to service the group's debt. Buy-out debt therefore sits above the regulated entity and is serviced from dividends the regulator permits — a structure the regulator reviews before approving the buyer.
Example
A payments company with €20m of EBITDA and no debt is bought for €200m. The buyer's structure: €90m of senior debt at 7%, €30m of mezzanine at 12% with warrants, €10m of vendor loan note, €70m of equity. Interest is €9.9m a year against €20m of EBITDA — cover of 2×, the lenders' floor. The regulated e-money subsidiary must hold €6m of own funds, which the structure leaves untouched in the entity; the debt is at the holding company and serviced from the subsidiary's dividends, which the regulator's approval letter caps at 80% of profit. In year two EBITDA falls to €15m: interest cover drops to 1.5×, the senior covenant is breached, the mezzanine lender's warrants become the price of a waiver, and the equity holders learn what the ranking meant. The company was worth the same €200m under either structure; the equity was worth €200m under one and €70m under the other, and the lenders' patience decided the rest.
Common mistakes
- Leverage set on a forecast, so one bad year is a breach. - Ignoring the ranking until the restructuring, when it is the only thing that matters. - Debt at the regulated entity that the regulator will not let its capital service. - Treating the target's cheap equity as free; it has a cost, and it is higher than the debt's. - A structure that is optimal on the spreadsheet and unfundable in the market.