What is capital structure?

Here you will learn all about what a capital structure is and why it is important to have a properly managed capital structure in your company.

Capital structure describes the composition of a company's financing, which consists mainly of two components: equity and debt.

• Equity: This consists of the company's own funds, including investments from owners, share capital, new share issues and retained earnings. Equity does not have to be repaid, but usually means that investors receive ownership stakes in the company and therefore expect a return.
• Debt: This includes bank loans, bonds and other credit. Debt must be repaid with interest, which can increase the company's fixed costs but can also enable faster growth through leverage.

What different capital structures are there?

Below we describe common types of capital structure.

Highly leveraged capital structure

A highly leveraged capital structure means that a larger share of the company's financing comes from loans and other debt. This can increase the return on equity thanks to leverage and interest deductions.

Advantages:

• Interest costs are tax-deductible, which reduces the company's tax burden.
• The possibility of a high return on equity, provided the business is profitable.

Disadvantages:

• Increased financial risk, especially if revenue is unstable.
• Risk of payment difficulties if the debt becomes too high.

Low-leverage capital structure

A low-leverage capital structure means that the company is largely financed with equity. This reduces the financial risk but can also limit growth opportunities.

Advantages:

• Lower risk of payment difficulties, since the company does not have large borrowing costs.
• Stronger financial stability and appeal to certain long-term investors.

Disadvantages:

• Higher cost of capital, since equity is more expensive than debt.*
• The company may be seen as less dynamic and growth-oriented.

*Equity is considered more expensive than debt because shareholders take on more risk than lenders and therefore demand a higher return. Unlike interest on debt, which is an actual cost and tax-deductible, the cost of equity is not a direct expense but a measure of the return shareholders expect for investing in the company.

Mixed capital structure

A mixed capital structure means a balance between equity and debt. This allows the company to combine stability with growth potential.

Advantages:

• An optimised cost of capital by balancing the advantages of equity and debt.
• Reasonable risk-taking that keeps the company flexible in the face of market changes.

Why is it good to have a mixed capital structure?

A mixed capital structure can be beneficial for several reasons:

• Optimal cost of capital: By combining equity and debt, the company can lower its total cost of capital, which strengthens profitability.
• Balanced level of risk: With a mixed capital structure, the company can avoid both the high risks that come with heavy debt and the high cost of capital of relying on equity alone.
• Flexibility: The company is better able to adapt to market changes by having access to different sources of financing.

Tips for a sustainable capital structure

Here are some tips for creating a capital structure that is sustainable in the long term:

1. Analyse the company's ability to pay: Make sure the company has enough revenue to service its debt without risking payment difficulties.
2. Adapt to the company's life cycle: Companies in a growth phase can often benefit from higher debt, while mature companies may need a more stable and mixed structure.
3. Consider the ownership structure: If you want to avoid diluting ownership stakes, loans can be a better alternative than new share issues.
4. Make use of tax effects: Tax rules in Sweden make interest costs deductible, which can make debt financing more attractive.

How can raising capital affect the capital structure?

Different methods of raising capital affect the company's capital structure in different ways:

• New share issue: Increases the share of equity and reduces leverage. However, it dilutes existing ownership stakes.
• Loans: Give quick access to capital without affecting the ownership structure, but increase debt and interest costs.
• Combination of a new share issue and loans: Can have a balanced effect on the capital structure, with both less dilution and limited borrowing costs.

Frequently asked questions

Below we answer common questions about capital structures.