What Is Capital Structure?
Capital structure is the combination of funding sources a company uses to finance its business, most commonly debt and equity. Every dollar of assets on a balance sheet is ultimately paid for by someone, and capital structure describes who those funders are and what they were promised in return. Debt holders receive contractual interest and principal payments, while equity holders own whatever value is left after all obligations are met.
A company's capital structure is often summarized with ratios like debt-to-equity or debt-to-EBITDA. A software company with little debt and a utility financed heavily with bonds can both be sensible, because the right structure depends on how stable and predictable the underlying cash flows are.
The Capital Stack
Capital structure is frequently visualized as a stack ordered by priority of claims. Senior secured debt sits at the top and gets paid first, followed by unsecured and subordinated debt, then hybrid instruments like preferred stock and convertible bonds, and finally common equity at the bottom.
Position in the stack drives both risk and expected return. Senior lenders accept lower interest rates because they are most protected in a downturn, while common shareholders demand the highest returns because they absorb losses first but capture unlimited upside.
Example
Suppose a company has an enterprise value of 1 billion dollars, funded with 400 million dollars of debt and 600 million dollars of equity. Its capital structure is 40 percent debt and 60 percent equity, and its debt-to-equity ratio is 400 divided by 600, or about 0.67x.
If the company generates 100 million dollars of EBITDA, its leverage is 4.0x debt-to-EBITDA. Lenders and rating agencies watch that multiple closely, because higher leverage means interest payments consume a larger share of cash flow and leave less cushion if earnings decline.
Why It Matters
Capital structure decisions affect a company's cost of capital, tax bill, credit rating, and flexibility to invest or survive a recession. Debt is usually cheaper than equity and interest is often tax deductible, but too much of it raises the risk of default and bankruptcy.
In investment banking and private equity, capital structure is a daily topic: leveraged buyouts are essentially capital structure engineering, and restructuring groups exist to fix structures that have too much debt. Understanding the capital stack is one of the most common themes in finance interviews.
