Corporate capital structure

Capital structure is mission critical

The optimalisation of corporate capital structure of companies is critical for the maximisation of profit by companies.

Corporate capital is made up of equity and debt, and hybrid instruments that blend features of both debt and equity in a single instrument.

Danziger Capital Partners LLP advises UK companies on optimal capital structure and on reducing costs of capital.

Differences between debt and equity

There are three main differences between debt and equity-

Is debt less safe than equity?

No. Even the least secure high-yield debt instrument or "junk bond" has more features that protect investor security, than the most venerated blue-chip share.

If the issuer of high-yield debt becomes distressed and does not pay, the debt instruments become ordinary shares, because -

Does debt result in financial weakness?

No. One of the most widely accepted propositions in economics is that debt is irrelevant to corporate value. Debt only matters when it has an effect on some other factor, such as the company's tax liability, or the likelihood of corporate bankruptcy, or when it affects the incentives of investors to monitor the conduct of managers.

Is debt superior to equity?

It's hard to say. But for any company, the question whether to take on debt is no different in principle to any other investment decision that the company takes, say, whether to invest in new plant, or whether to issue preference shares rather than debentures.

Does debt distort management priorities?

Debt puts management under pressure - the pressure to raise cash periodically in order to comply with the repayment obligations imposed by the debt contract.

Does that mean that managements are forced by leverage to concentrate on short-term profits, rather than long-run corporate value, in order to ensure that there is cash on hand to pay debtholders? No. If a company wishes to undertake a project that promises to generate good long-term returns, but a cash outflow in the short term, then the company will be able to raise money to finance the project from equity investors, while it repays debtholders from the proceeds of existing projects.