Capital Structure Theories^297
investments and fund it by long term sources. If on the other hand, the business is
seasonal in nature, the seasonal peaks fund requirements may have to be funded by
short term debt.
Cyclical Business: In businesses like construction, capital and higher consumer goods
their volumes, and hence requirements of funds, are affected by the changes in the
national and global scene. Businesses subject to such variations need a capital structure
that can buffer the risks associated with such swings. Again manoeuvrability of capital
structure, is at a premium during times of contraction.
Competition: The degree of competition is also a major factor to be considered in
deciding the capital structure. In highly competitive industry with low entry barriers,
companies with deep pockets can only survive in the long run.
Product or business life cycle: During the initial phase of the growth curve of a
business/product the risk is high. Debt is hard to come by due to the riskiness of the
venture and funding has to be through the venture capital equity. Financial leverage is
low, which could be increased as the product/business establishes itself. As the business
matures, increased cash flows may reduce the need for debt funds.
Current and Past capital Structure
Current capital structure of a company is determined largely by past decisions. Investment
decisions of the past, acquisitions, take-overs, financing policy, dividends etc. go into
forming the current capital structure which is difficult to change overnight. Altering
current capital structure can be done by raising capital, retiring debts, buying back
shares, taking on debt, altering dividend payout policies, alteration in earning capacity,
etc. Also, as past decisions decide current capital structure, current changes in the
capital structure decide the future capital structure. Hence, utmost care has to be
exercised in decision and implementation of changes in the capital structure.
While making the capital structure decisions, the company has to consider the different
life cycle stages which are :
l the pioneering stage
l the expansion stage
l the stagnation/stabilisation stage
The pioneering stage is one of rapid increase in demand for the products/services of
the company. The risk is highest at this stage of the life cycle of the company and the
efficient companies are the ones to survive. The financial cost of borrowing is very
high at this stage, due to the risk perception about the company. To survive this the
capital structure should orient more towards equity and if available utilise soft loans
from the government.