Capital Structure: Equity vs. Debt
A company’s capital structure is the relative proportion of equity and debt used to finance assets and operations. A company’s capital structure determines both the nature of its stakeholders and its expected cost of capital.
Capital Structure Balance
The combination of debt and equity to finance assets varies from one industry to another and from company to company. However, in general, companies attempt to balance the trade-off between maximizing returns and minimizing business risk. Because equity is “more expensive” than debt (that is, it requires a higher expected return), a company may reduce its weighted average cost of capital (WACC) by altering the capital structure to favor a higher percentage of debt (thereby increasing financial leverage to boost returns). However, this must be balanced against cash flow requirements and other liquidity constraints.
See future blog posts for discussions about how capital structure affects a company’s cost of capital and about agency issues that may pit debt, equity and management stakeholders against each other.
Find both debt and equity providers at www.PrivateEquityInfo.com. Private Equity Info is a regularly-updated, powerful database of private equity firms, hedge funds, mezzanine investors, small business investment companies, valuation firms, M&A advisory firms, institutional real estate investors and senior lenders.
To see the Weighted average cost of capital of publicly traded firms, you can look at http://www.ThatsWACC.com, which will calculate the WACC and show the cost of capital and debt (and relative proportions of each) for (US-traded) companies.