capital-structure-and-covenants

# Capital structure and covenants Financing is not only where the money comes from. It is a set of ongoing constraints that will shape operating decisions for as long as the facility exists, and most of those constraints are discovered late. ## Cost of capital sets the hurdle, so compute it rather than choosing a round number Weighted average cost of capital blends the after-tax cost of debt and the cost of equity in the proportions actually used. It is the rate an investment has to clear before it creates value. Debt is cheaper than equity — the rate is lower, the interest is deductible, and the claim is senior. That cheapness is exactly why leverage is tempting, and why the temptation needs a limit set in advance. Equity has a cost even though nobody writes a check for it; treating it as free is how capital gets consumed by projects that never earned their keep. ## Size leverage to the bad case, not the plan Leverage amplifies returns on equity and amplifies losses, and the losses arrive first because debt service does not wait for recovery. Capacity is governed by the stability of cash flow, not by an industry average ratio. A predictable subscription business carries debt that a project business with lumpy collections cannot. The question is never "can we service this at plan" — it is "can we service this at the plan we would be embarrassed to show anyone." ## Covenants are where financing becomes an operating constraint - **Financial covenants** — leverage ratio...