Capital Structure: 28 Key Terms

By Devon Coombs, CPA, MBA · Teaching Professor of Finance, Santa Clara University · Reviewed August 2026

Capital structure refers to the mix of debt and equity a company uses to finance its operations, together with the tradeoffs that mix creates for cost of capital and control. The terms collected here range from the components of the capital stack and financial leverage to the frictions that shape financing choices, including agency costs, adverse selection, and financial distress costs. Understanding concepts such as covenants and free cash flow discipline helps explain why debt can impose useful constraints even on a growing startup, a theme examined in the free Entrepreneurial Finance course.

These terms are taught in Week 8: Capital Structure of the free Entrepreneurial Finance course; the full course glossary collects every chapter in one place.

Acceleration: A lender's right, on a covenant breach or default, to demand immediate repayment of the outstanding principal.
Adverse selection: The market's inference that a firm issuing equity may be overvalued, which pushes the price down and makes equity costly.
Agency costs: Costs from conflicts of interest between managers, shareholders, and lenders (Jensen and Meckling, 1976).
Asset substitution: An agency cost of debt in which levered shareholders favor risky projects whose upside is theirs and downside falls on lenders.
Capital stack: The full set of a firm's financing claims, from senior secured debt down to common equity.
Capital structure: The mix of debt, equity, and hybrid securities a firm uses to finance its assets.
Cost of capital: The return a firm needs to earn on its assets to satisfy its investors, expressed as a rate.
Cost of debt: The interest rate a lender charges. Its after-tax value reflects the interest tax shield for a profitable firm.
Covenant: A condition in a loan agreement, such as a minimum cash balance or growth milestone, whose breach can trigger acceleration.
Financial distress costs: The costs that rise with leverage: lost customers, fire-sale asset values, and legal and bankruptcy expenses.
Financial leverage: The use of debt in the capital structure, which magnifies both returns and risk to equity.
Free cash flow discipline: Jensen's (1986) argument that required debt payments force out excess cash and curb wasteful managerial spending.
Hybrid instrument: A security that blends debt and equity features, such as a convertible note or a SAFE, that converts to equity later.
Information asymmetry: The gap between what managers know and what investors know, which drives the pecking order and adverse selection.
Interest tax shield: The value created because interest is tax-deductible. Under MM 1963, it adds Tc times the debt to firm value.
Levered value: The value of a firm with debt. Under MM 1963, unlevered value plus the interest tax shield.
MM Proposition I: In perfect markets with no taxes or frictions, firm value is independent of the financing mix (Modigliani and Miller, 1958).
MM Proposition II: The cost of equity rises linearly with the debt-to-equity ratio, offsetting the use of cheaper debt so WACC is unchanged without taxes.
Net operating loss (NOL): A tax loss that can be carried forward to offset future taxable income, the deferred value of a startup's early losses.
Pecking order theory: Under information asymmetry, firms prefer internal funds, then debt, then equity (Myers and Majluf, 1984).
Personal guarantee: A founder's personal promise to repay company debt, which turns much new-firm bank debt into a levered claim on the founder.
Revenue-based financing: Capital repaid as a share of revenue, available once a firm has recurring revenue to share.
Section 382: A tax provision that limits the use of NOLs after an ownership change exceeding 50%, which venture rounds frequently trigger.
Signaling: The idea (Ross, 1977) that taking on fixed debt payments signals management's confidence in the firm's cash flows.
Tradeoff theory: Optimal leverage balances the marginal interest tax shield against the marginal cost of financial distress, giving an interior optimum.
Unlevered value: The value of a firm financed entirely with equity, before any tax shield from debt.
Venture debt: A term loan for venture-backed firms, commonly 25 to 35% of the last round at 8 to 15% interest with warrants, used to extend runway.
Warrant: A right to buy shares at a set price, attached to venture debt as additional lender compensation, causing modest dilution.

More Entrepreneurial Finance term guides

Put the vocabulary to work: the free calculators and decision guides apply these terms, and the free Entrepreneurial Finance course teaches them in context.