Legal Definitions - capital structure

Capital structure refers to the specific combination of different funding sources a company uses to finance its operations and growth. Essentially, it's the way a business raises money, primarily through borrowing (known as debt) and selling ownership shares (known as equity).

This mix includes various forms of debt, such as short-term loans or long-term bonds, and different types of equity, like common stock or retained earnings. Understanding a company's capital structure is crucial because it impacts its financial risk, cost of capital, and overall valuation.

• Example 1: A Growing Tech Startup

  Imagine a new software company that needs significant funds to develop its product and hire engineers. They secure a loan from a venture debt fund (a form of debt) and also attract investment from venture capitalists who receive a percentage of ownership in the company (a form of equity). The specific proportions of this venture debt versus the venture capital investment define the startup's capital structure. This mix allows them to fund their initial operations without solely relying on one type of financing.

• Example 2: An Established Manufacturing Firm

  Consider a large automotive parts manufacturer planning to build a new, automated factory. To finance this multi-million dollar expansion, they decide to issue corporate bonds to institutional investors (long-term debt) and also allocate a portion of their accumulated profits, which are reinvested into the business (a form of equity called retained earnings). The balance between the money raised from issuing bonds and the profits they've reinvested constitutes their capital structure for this major project, reflecting how they've chosen to fund their long-term assets.

• Example 3: A Local Retail Business

  A popular neighborhood bakery wants to open a second location and purchase new, specialized ovens. The owner decides to take out a commercial mortgage for the new property (long-term debt) and also invests additional personal savings into the business (owner's equity). The combination of the bank loan and the owner's personal investment forms the bakery's capital structure for its expansion. This illustrates how even smaller businesses strategically combine different funding sources to achieve their goals.