What is a Simple Capital Structure?

//What is a Simple Capital Structure?
What is a Simple Capital Structure? 2017-10-10T06:55:40+00:00

Definition: A simple capital structure refers to a corporation that does not issue dilutive securities to finance its organization. In other words, the capital structure is made up of only common stock and non-convertible preferred stock. This is referred to as simple because no outstanding securities can increase the number of outstanding shares and dilute the ownership and value of the current common shareholders.

What Does Simple Capital Structure Mean?

In this sense, it is simple because the only way to increase the number of common shares is for the board of directors to issue new shares. Since common shareholders typically have the preemptive right to maintain their existing ownership percentages, they can purchases the newly issued shares before anyone from the public.

In contrast, a corporation that has dilutive securities; like stock options, convertible preferred shares, and stock rights; is much complex because the number of outstanding common shares is not controlled by the board of directors or the company itself. The dilutive security owners control when they cash in or convert their securities to common stock. The board of directors and the current common shareholders have no say in when this happens.

Example

For example, many executives are paid a salary along with stock options. These options consist of rights to purchase common stock at a set price for a set amount of time. Depending on the stock price and the price stated on the option, the executive might choose to exercise his options early, on time, or not at all. For instance, if the stock price falls below the option price, the executive would be better off buying the shares on the open market instead of using his options.

As you can see, a corporation capital structure is much complex with dilutive securities than without them. A simple capital structure consists of only common shares and non-convertible preferred.