Complex capital structure

A complex capital structure is one in which there are potentially dilutive securities that can reduce profit per share (BPA).

Within their own resources, companies can opt for different types of securities to finance their activity. Some of these securities may be convertible into ordinary shares such as options , warrants or convertible securities of different types such as bonds or preferred shares .

Companies with complex capital structures have these titles to finance their activity, unlike simple capital structures . Depending on the moment they are in, they can decide whether they convert some of them into ordinary shares or not. Therefore, a complex capital structure will contain both non-convertible securities and potentially dilutive convertible securities.

Although it is important to keep in mind that this is not always the case. Some securities, such as convertible bonds, for example, could increase the profit per share derived from the cost savings that would mean for the company to stop paying the interest on those bonds. That is, although more titles would be added to the capital structure, interest savings would compensate for that greater amount of titles.

Complex capital structure

The company XYZ has issued 10,000,000 titles. The net income is 60,000 and its capital structure is as follows:

  • 5,000,000 ordinary shares.
  • 2,000,000 non-convertible preferred shares with a dividend of 5% and a nominal of € 100.
  • 3,000,000 bonds convertible into shares. These bonds are each converted into 2 shares, have a nominal of € 1,000 and a 5% coupon. The tax rate is 30%.

As we can see in the capital structure of the company, convertible bonds could have a dilutive effect on the company’s BPA. To verify this, you would first have to calculate the BPA without converting the effect of the bond conversion and recalculate the BPA with the bond conversion. If the BPA were lower, the bonds would have a dilutive effect on it.

Optimal capital structure

The optimal capital structure has been studied extensively by the branch of corporate finance.
The theoretical framework for the optimal capital structure was proposed by Modigliani and Miller. Although this theoretical framework assumes a somewhat ideal market (there are no taxes and the market is perfect) it has served for years as a basis for studying the impact of the capital structure on the value of the company.

 

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