The optimal capital structure for your company

The success of a company rises and falls with a good capital structure. Important financing decisions must be made both at the founding of a startup and later in the business process. These criteria must be considered by business managers.

The capital structure is the ratio of equity to debt of a company. Because many different forces influence the capital structure, it is difficult to find the optimal ratio of debt to equity. The following three factors should be included in financing considerations.

Interests of the Capital Providers

The goal of equity providers is to maximize the value of the company. By increasing the value of the shares or distributed profits, their wealth is increased. Equity providers usually have a long-term time horizon and are willing to take risks for potential profits. Debt providers, on the other hand, are solely interested in securing the funds they provide and the interest on them. Consequently, debt providers have a shorter time horizon and a lower risk tolerance. Unifying the wishes and interests of both parties is a challenge.

Cost of Capital

There can be costs associated with obtaining capital itself. For instance, fees must be paid for going public. Also, searching for people who are willing to lend money to the company can be costly and time-consuming. In return, debt financing offers tax advantages. The interest on a loan is tax-deductible. Equity, unlike debt, is also double-taxed. Therefore, one factor in searching for the right capital structure is the costs of raising capital.

Independence and Flexibility

Debt financing also entails a binding effect. The company must be able to repay the borrowed amount plus interest to the lenders. This reduces independence and responsiveness. A company that wants to remain flexible in its decision-making processes, therefore, needs more equity. Even if cash flows are volatile or still uncertain, financing with equity is preferable. Otherwise, there is a risk that the demands of the creditors cannot be met. Especially for startups, there is usually a great need for flexibility.

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