What is a Simple Capital Structure?

A corporation with a simple capital structure does not have any securities outstanding that could potentially dilute the value of its earnings per share. This means that its capital structure includes no more than common stock and non-convertible preferred stock. When this type of financing structure is present, there are no securities that could potentially be converted into common stock, thereby diluting the ownership interests of existing shareholders. Smaller companies frequently have simple capital structures, while larger entities are more likely to have complex capital structures.

Benefits of a Simple Capital Structure

There are several benefits associated with using a simple capital structure, which include the following:

Easier to understand. A simple structure is straightforward, making it easier for investors to analyze and value the company.
Clear ownership. Common equity holders have a direct claim on profits and assets, avoiding confusion over priority or dilution.
Less complex reporting. Reporting earnings, ownership, and shareholder rights is less complicated, as there are fewer instruments to account for.
Easier accounting compliance. Compliance with accounting standards and regulations is more straightforward.
Reduced legal costs. Fewer securities mean fewer legal documents, filings, and regulatory concerns.
Reduced dilution risk. Without convertible bonds or preferred shares, there’s no risk of future dilution from conversion.
Fewer competing claims on profits. Equity holders don’t have to share residual profits with holders of hybrid securities.
Simpler investment risk assessment. Investors can assess their potential returns and risks more easily.

In summary, a simple capital structure fosters transparency, while reducing the administrative burden and potential risks.

Disadvantages of a Simple Capital Structure

The main concern with a simple capital structure is that a business is not taking advantage of the lower-cost debt options that are available to it as part of a complex capital structure. For example, investors typically accept a lower interest rate on convertible bonds, since they see a benefit in the convertibility feature of the bond. A business that does not want to offer convertible bonds would have to accept higher interest rates on its debt.