A company that needs capital to fund its operations or growth has essentially two fundamental ways to raise it: debt, borrowing money that must be repaid on a fixed schedule with interest regardless of how the company actually performs, or equity, selling partial ownership stakes to investors who share directly in the company's future profits and losses but who are never contractually entitled to be repaid at all. A company's capital structure is simply the specific mix of debt and equity it uses to fund itself, and that mix has real consequences for who bears risk and in what order they get paid.
Debt comes with a fixed repayment obligation that doesn't bend to performance
When a company borrows debt, it takes on a contractual obligation to repay the borrowed principal along with interest according to a fixed schedule, regardless of whether the company's underlying business actually performs well or poorly during that period. This fixed obligation is exactly what makes debt riskier for the company itself relative to equity: a company that misses a scheduled debt payment can be pushed into default and, ultimately, bankruptcy, even if its long-term business prospects remain genuinely strong, simply because the debt's fixed repayment terms don't flex to accommodate a temporarily difficult period.
Equity shares ownership and risk but carries no fixed repayment demand
Equity works differently: investors who buy equity become partial owners of the company, sharing directly in its future profits, or losses, in rough proportion to their ownership stake, but the company itself has no contractual obligation to repay equity investors a fixed amount on any particular schedule. This makes equity considerably more flexible for the company during difficult periods, since there's no fixed payment that can be missed and trigger default, but it comes at its own cost: equity investors typically demand a higher expected return than debt lenders do, precisely because they're bearing more risk with no fixed, contractually guaranteed repayment to fall back on, and existing owners give up a genuine share of future ownership and control by issuing new equity.
What we're still unsure about
The basic debt-versus-equity distinction, and how each affects a company's risk and repayment obligations, are well established, foundational corporate finance concepts. What remains a genuinely active area of ongoing finance research and real debate is exactly how a given company should determine its own optimal mix of debt and equity, since more debt typically lowers a company's overall cost of capital, thanks to debt's tax-deductible interest and lower required return, right up until the added bankruptcy risk from carrying too much debt starts to outweigh those benefits — financial economists continue to actively study and debate exactly where that optimal balance point lies, and how much it varies by industry and individual company, rather than there being one universally correct target ratio.
This sits inside Corporate Finance & Capital Structure, one of eight topics in Finance, one of five domains in Economics, one of seventeen subjects the app can quiz you on.