Capital Structure
You need money to buy a house. The bank won't give you a loan (the result of some pesky details surrounding a land deal in Florida from a while back...no need to tell the whole story here). So now what? Wouldn't it be great if there was another option? What if you could sell stock in yourself, the way companies do? (That Florida land thing might come up there too, but you can take your chances.)
If you went public, you might not get too many buyers, but companies usually do. The fact that companies can raise funds by selling stock on the public market gives them a choice. They can choose between debt and equity (and usually use a combination of the two) in order to finance daily operations and to expand their business. This is known as their capital structure. It's the way a company has financed itself.
A given company might have $800M in debt, while raising $250M in equity and have $300M in cash on their books. Meanwhile, it has other assets, like a factory worth $425M after having been depreciated from $800M and patents worth $100M. The debt could be in the form of bank loans or it could come from issuing bonds. Equity would include common and preferred stock.
The trick in optimizing the capital structure is to find the right mixture of debt and equity, remembering that when you sell debt, you have to pay it off at some point (presumably). When you sell equity, on the other hand, you've sold ownership in yourself forever.
The right mix in the capital structure varies by context. The company's accountants and outside analysts often use a fairly simple comparison to study a company's capital structure. It's called the debt-to-equity ratio.
As the name implies, this figure provides the ratio between a company's debt and its equity. You calculate this by dividing the firm's total debt by its total equity.
One of the benefits of debt is that interest payments are tax deductible. You also don't have to give up any company ownership like you would with selling stock. With equity, you don't have to pay any money back like you would with a loan or bond issue, but you give up a piece of ownership in the company.
Related or Semi-related Video
Finance: What is recapitalization?34 Views
finance a la shmoop what is recapitalisation all right people think
nee capitalization you know in Jersey like when you owe the mob money at least [thug breaks knee with bat]
that's what it feels like if you're a common equity stockholder of a company [businessman with common stock]
that has been recapped well usually recapitalisation is a very kindly loving
politically correct term for a pal you're bankrupt you borrowed money you
promised to pay back and you didn't so now you're out and the lenders now own
your company buh and buy so typical recap comes from a company that was very
early stage and had preferred stock upon preferred stock from venture capital
investors sitting above their common in the priority stack and eventually the
company burned through eighty seven million dollars and it has just a [dollars on fire]
million bucks left in the bank and it built something out of that eighty seven [company logo graveyard]
million not quite worth putting here yeah but it might be worthy of a new
investment of say yo thirty million or more dollars but the marketplace values [money going into company briefcase]
this zombie company yes that's what they're called at a [zombie briefcase walking at night]
value well less than the eighty seven million that has been raised previously
so everything is marked down usually with a common in total being worth [store during closing sale]
something like one percent of the new company and that's oh so sad for the
founders because it was a hundred percent of the company the day they
started so they were recapped and lest more mature companies feel left out well
recapitalisation happens in later stage companies as well and the radio industry
famously took on too much debt in the late 1990s and then people stop [radio knob getting changed]
listening to Drivetime radio as cell phones and satellite radio intruded I
bring radio borrowed five billion dollars at seven percent to oh three
hundred fifty million a year and then when cash earnings fell well below that
number while the company had to recap its five billion of debt such that those
debt holders now own essentially all of I brain radio and hope to someday milk
enough cash out of it to get their principal back knowing and it'll likely [goat getting milked]
be a very low interest rate or a low return on their and
if a positive one at all hopefully that all made sense you the first time though
because well we don't have time here in this video for a recap
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