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. 

What is capital structure?

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

• Equity capital: This consists of the company's own funds, including investments from owners, initial capital, new share issues and retained earnings. Equity does not have to be repaid, but usually means that investors receive ownership shares in the company and thus expect a return.
• Shoulder: This includes loans from banks, bonds and other credits. Debt requires repayment with interest, which can increase the firm's fixed costs but also allow for faster growth through leverage.

What are the different capital structures?

Below we describe common types of capital structures. 

Highly leveraged capital structure

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

Benefits and advantages:

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

Disadvantages:

• Increased financial risk, especially if revenues are unstable.
• Risk of payment difficulties if debts become too high.

Capital structure with low leverage

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

Benefits and advantages:

• Lower risk of payment difficulties as the company does not have high borrowing costs.
• Stronger financial stability and attractiveness for some long-term investors.

Disadvantages:

• Higher cost of capital because equity is more expensive than debt.
• The company may be perceived as less dynamic and growth-oriented.

*Equity is considered more expensive than debt because shareholders take more risk than lenders and therefore require higher returns. Unlike interest on debt, which is an actual cost and deductible, the cost of equity is not a direct expense but a measure of the return that 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.

Benefits and advantages:

• Optimized cost of capital by balancing the benefits of equity and debt.
• Reasonable risk-taking that makes the company flexible to changes in the market.

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 the total cost of capital, which strengthens profitability.
• Balanced risk level: With a mixed capital structure, the company can avoid the high risks that come with a high level of debt and the high cost of capital from equity alone.
• Flexibility: The company is better able to adapt to market changes by having access to different sources of finance.

Tips for having a sustainable capital structure

Here are some tips for creating a long-term sustainable capital structure:

1. Analyze the company's solvency: Ensure that the company has sufficient revenue to manage debt without risking payment difficulties.
2. Customize for your business lifecycle: Companies in the growth phase can often benefit from higher leverage, while mature companies may need a more stable and mixed structure.
3. Take into account the ownership structure: If you want to avoid dilution of shareholdings, loans may be a better option than new issues.
4. Exploiting tax effects: Tax rules in Sweden make interest costs tax deductible, which can make debt financing more attractive.

How can raising capital affect the capital structure?

Different methods for Raising of capital affects the capital structure of the company in different ways:

• New issue: Increases equity and reduces debt. However, it implies dilution of existing shareholdings.
• Loans: Provides quick access to capital without affecting the ownership structure, but increases debt and interest costs.
• Combination of new issue and loan: Can provide a balanced impact on the capital structure with both less dilution and limited borrowing costs.

Frequently asked questions

Below we answer frequently asked questions on the topic of capital structures. 

What is a good capital structure?

A good capital structure is often a mixed capital structure that balances equity and debt. However, the company's industry, size and growth objectives influence what is optimal.

What is the definition of a capital structure?

Capital structure is the distribution between a company's equity and debt. It affects a company's risk-taking, cost of capital and growth opportunities.

What is a simple formula for capital structure?

A simple formula for capital structure is: total debt / equity = capital structure leverage ratio.