What is a Complex Capital Structure?

A business has a complex capital structure when it has issued other types of equity than just common stock. A startup company commonly develops a complex capital structure over time, as it goes through multiple rounds of financing. This is typically done in order to entice additional investors to provide the firm with funding, based on their particular needs. If the business ever goes public, it cleans up this capital structure by converting its various classifications of stock into common stock. When a firm has a complex capital structure and is publicly held, it must report its fully diluted earnings per share.

Characteristics of a Complex Capital Structure

The key characteristics of a complex capital structure are as follows:

May include convertible securities. A complex capital structure typically includes securities such as convertible bonds, convertible preferred stock, or other instruments that can be converted into common shares.
May include stock options and warrants. The issuance of employee stock options, warrants, or rights to purchase common stock at predetermined prices adds complexity due to their potential dilutive effect.
May include multiple classes of stock. Having multiple classes of stock (such as Class A, Class B, preferred, etc.), each with distinct rights and privileges, characterizes a complex capital structure.
Dilutive potential. Instruments within a complex capital structure can potentially dilute existing common shareholders' interests when conversion occurs, reducing earnings per share.
Increased disclosure requirements. Complex capital structures necessitate more detailed disclosures to investors regarding instruments’ terms, conversion features, potential dilution, and effects on earnings per share.

Example of a Complex Capital Structure

A startup company is having a difficult time attracting investors, so it offers them Series A preferred stock that pays a 4% dividend, followed by Series B preferred stock that pays a 7% dividend, and then Series C preferred stock that has extra voting privileges. In addition, it has to offer its key employees stock options in order to convince them to work for the company at low salary levels. Finally, it must offer investors convertible bonds in order to keep the interest rate low, while giving them the option to convert their bond holdings into the company’s common stock, in case the firm’s value increases.