Capital Structure

What Is Capital Structure?

Capital structure refers to the combination of debt and equity that a company uses to finance its business. In M&A, a target’s capital structure determines its enterprise value, influences how the acquisition is financed, and shapes the post-deal balance sheet. For acquirers — particularly private equity firms executing leveraged buyouts — optimising capital structure is central to generating returns.

The fundamental relationship is: Enterprise Value = Equity Value + Net Debt. A company’s capital structure determines how enterprise value is distributed between equity holders and debt holders, and any change to the capital structure shifts value between these stakeholders.

Components of Capital Structure

Component	Description	Cost	Priority in Liquidation
Senior secured debt	Bank loans, first lien bonds	Lowest	Highest
Senior unsecured debt	Bonds without collateral	Low-medium	High
Subordinated/mezzanine debt	Mezzanine financing	Medium-high	Medium
Preferred equity	Hybrid instrument with fixed dividends	High	Low
Common equity	Ordinary shares	Highest (residual)	Lowest

The Capital Structure Waterfall

In a liquidation scenario, claims are paid in strict priority order. Senior secured creditors are paid first, followed by unsecured creditors, subordinated debt holders, preferred equity, and finally common equity. This priority structure — known as the waterfall — directly affects risk and return for each tranche.

Capital Structure in M&A Valuation

Enterprise Value Bridge

When valuing a target for acquisition, the capital structure determines the bridge from enterprise value to equity value:

Enterprise Value (EV)
  − Total Debt
  − Preferred Equity
  − Minority Interests
  + Cash and Equivalents
  = Equity Value

The cash-free, debt-free convention used in most M&A transactions normalises for capital structure by pricing the business at its enterprise value and adjusting for actual debt and cash at closing. This allows buyers to compare targets with different capital structures on an apples-to-apples basis.

Weighted Average Cost of Capital

A company’s WACC — the blended cost of its debt and equity — serves as the discount rate in DCF valuations. Capital structure directly affects WACC because debt is typically cheaper than equity (due to the tax deductibility of interest and lower risk), but excessive debt increases financial risk and raises the cost of both debt and equity.

Capital Structure in LBOs

Leveraged buyouts are fundamentally capital structure transactions. The private equity sponsor acquires the target using a combination of equity (typically 30-40% of the purchase price) and debt (60-70%), with the target’s own assets and cash flows serving as collateral and debt service.

The LBO capital structure typically includes:

• Senior bank debt — revolving credit facility and term loans
• High-yield bonds — unsecured debt with higher interest rates
• Mezzanine or subordinated debt — junior financing that fills the gap between senior debt and equity
• Sponsor equity — the private equity firm’s investment, funded from its fund

According to Bain & Company’s Global Private Equity Report, average leverage multiples in US buyouts fluctuated between 5.5x and 7.0x EBITDA over the 2019-2024 period, with the optimal level depending on the target’s cash flow stability, growth profile, and industry dynamics.

Post-Acquisition Capital Structure

After an acquisition closes, the combined entity’s capital structure must be managed to:

• Service the acquisition debt without constraining operations
• Maintain adequate liquidity for working capital and growth investment
• Preserve financial flexibility for bolt-on acquisitions or strategic pivots
• Meet covenant requirements in the debt agreements

Overleveraged post-deal capital structures are a leading cause of acquisition failures. When debt service consumes too much cash flow, the business cannot invest in growth, retain talent, or weather economic downturns — ultimately destroying the value the acquisition was intended to create.

APAC Context

Capital structure norms vary significantly across Asia Pacific markets, affecting M&A valuation and financing:

Japan — Japanese companies have historically maintained conservative capital structures with low leverage. The ongoing corporate governance reforms and Tokyo Stock Exchange’s push for higher capital efficiency are driving increased leverage and more active capital allocation, which is expanding the universe of potential LBO targets.

India — the Reserve Bank of India regulates leverage ratios for both domestic and foreign-financed acquisitions. Cross-border acquisition financing must comply with External Commercial Borrowing guidelines, which impose sectoral caps, all-in cost ceilings, and end-use restrictions on foreign debt.

Australia — leveraged acquisition financing benefits from a well-developed syndicated loan market and sophisticated securitisation infrastructure. However, the financial assistance provisions of the Corporations Act restrict a target company’s ability to provide security over its own assets to finance its acquisition — requiring careful structuring of post-deal capital arrangements.

“Capital structure is where M&A strategy meets financial engineering,” notes Daniel Bae, founder of Amafi. “In APAC leveraged transactions, the optimal structure depends not just on the target’s cash flows but on local regulatory constraints on leverage and financial assistance.”

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Optimising acquisition financing across Asia Pacific? Amafi helps companies and investors structure transactions for maximum value. Learn more.