Lesson 2 of 6 · All lessons in this module
- The cost of capital and WACCVideo lesson
- How much financing, and what kind: business model and life cycle
- What drives the costs of debt and equity
- Modigliani-Miller without taxes: capital structure irrelevanceVideo lesson
- Modigliani-Miller with taxes, and the cost of financial distressVideo lesson
- Optimal and target capital structures, pecking order and agency costsVideo lesson
Lesson 2 of 6 · 13 min
How much financing, and what kind: business model and life cycle
The business model decides how much capital a company needs, and its stage in the life cycle decides how much of that can be debt: cash-burning startups rely on equity, mature cash generators borrow cheaply.
In short
- Internal factors: business model, life-cycle stage, cash flows and profitability, asset types. External factors: capital market and economic conditions, regulation, industry.
- Capital-intensive firms (utilities, transport, real estate, chip making, resources) show low asset turnover, high capex/sales and high working capital/sales.
- Capital-light firms (platforms, many tech and service firms) need little financing: users own the assets, customers pay upfront, staff are paid partly in shares.
- Tangible, fungible assets can be leased or used as collateral, giving a lower cost of debt.
- Startup: negative FCF, high risk, equity from founders, staff and VC; only leases or convertible debt. Growth: rising FCF, secured debt used cautiously. Mature: stable FCF, significant unsecured debt.
- Regulation (bank capital rules, utility rate setting) often forces more equity, raising WACC.
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