Equity = amounts invested by the owners of the business (SHARE CAPITAL) (RETAINED PROFITS) LOWER RISK, LOWER REWARD
Debt = Finance provided to the business by external parties (BANK LOANS) (OTHER LONG-TERM DEBT) HIGHER RISK, HIGHER REWARDS (MAKING PROFIT ON OTHERS’ MONEY)
Reasons for higher equity in capital structure:
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where there is greater business risk (startups)
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where more flexibility required (don’t have to pay dividends, with a loan you have to pay interest)
Reasons why high levels of debt can be an objective
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where interst rates are very low = debt is cheap to finance
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where profits and cash flows are strong; so debt can be repaid easily (unicorn businesses)