Debt capital is the capital that a business raises by taking out a loan. It is a loan made to a company that is normally repaid at some future date. Debt capital differs from equity or share capital because subscribers to debt capital do not become part owners of the business, but are merely creditors, and the suppliers of debt capital usually receive a contractually fixed annual percentage return on their loan, and this is known as the coupon rate.
Debt capital ranks higher than equity capital for the repayment of annual returns. This means that legally, the interest on debt capital must be repaid in full before any dividends are paid to any suppliers of equity.
A company that is highly geared (UK), or leveraged (US), has a high debt-to-equity capital ratio. As we already said that debt capital is a loan. This money (which was given to the company as loan) is given to the debt holders first before giving it to preference holder and equity holders. Equity holders (shareholders) have all rights in the business, but the debt holders have no rights on the business.
- Corporate Finance: Theory and Practice, by Steve Lumby and Chris Jones, Thompson, London.