Debt Capital

What is debt capital?

Debt capital (German: Fremdkapital; also known as debt) refers to the funds that creditors make available to a company and that it must repay regardless of business success. On the balance sheet it comprises the company's debts, that is, provisions and liabilities. It is comparable to a car paid for partly from savings and partly with an instalment loan: the loan has to be repaid whether or not the car proves its worth.

Formula: Debt capital = total assets − equity = provisions + liabilities + other items on the equity and liabilities side such as deferred income

Debt capital is the counterpart to equity. Creditors have a fixed claim to repayment and usually to interest, but as a rule no voting rights and no share of profit. Creditors include banks, suppliers, customers who have made advance payments, shareholders with loans, but also the tax authorities and employees. Debt capital is governed mainly by loan and security agreements. In funding rounds and company sales, it determines the financing mix, the focus areas of due diligence and the purchase price that reaches the shareholders.

Types and examples of debt capital

• By maturity: short-term debt capital with a remaining term of up to one year, such as trade payables or an overdraft facility (credit line on the business account); medium- and long-term debt capital, such as investment loans and promotional loans.
• By instrument: bank loans, promotional loans, venture debt, shareholder loans, promissory note loans (Schuldscheindarlehen) and bonds, supplier credit and advance payments received.
• By interest: interest-bearing financial liabilities and non-interest-bearing debts such as trade payables or most provisions.
• By ranking and security: secured senior loans, unsecured claims and subordinated funds, which in insolvency are only satisfied after the other creditors.

Hybrid instruments sit between equity and debt. Mezzanine capital such as subordinated loans or typical silent partnerships is often treated by banks as equity in economic terms, but under commercial law usually remains debt capital. A convertible loan is likewise debt capital until conversion.

Accounting under the German Commercial Code (HGB)

On the equity and liabilities side of the balance sheet, Section 266 (3) of the German Commercial Code (Handelsgesetzbuch, HGB) lists, alongside equity, provisions, liabilities, deferred income and deferred tax liabilities. Deferred income consists of payments received in advance for later services, deferred tax liabilities of future tax charges arising from differences compared with the tax balance sheet. Provisions must be recognised for uncertain liabilities and for impending losses from onerous contracts (schwebende Geschäfte). Like liabilities, they are recognised at their settlement amount (Section 253 (1) HGB), but discounted where the remaining term exceeds one year. In balance sheet analysis, deferred income and deferred taxes are usually counted as debt capital.

Corporations (Kapitalgesellschaften) classify liabilities by remaining term and state secured amounts in the notes to the accounts. For the GmbH (German limited liability company), liabilities to shareholders must be shown separately or disclosed in the notes (Section 42 (3) of the German Limited Liability Companies Act, GmbHG). Guarantees given in favour of third parties are not debt capital but contingent liabilities.

Cost of debt capital

Besides interest, the costs include arrangement fees, commitment fees for funds not drawn, any disagio (loan discount) and the costs of security. With venture debt, a right to a stake in the company (warrant) is often added. Only the effective interest rate makes offers comparable. Not measurable in money, but often of similar importance, are conditions (covenants), consent requirements and information duties.

Interest is in principle deductible as a business expense. The interest barrier (Zinsschranke) applies when the net interest expense of a year, that is, interest expense less interest income, reaches EUR 3 million (as of 2026). The deduction is then in principle limited to 30% of tax EBITDA (Section 4h of the German Income Tax Act, EStG, and Section 8a of the German Corporation Tax Act, KStG). For trade tax purposes, one quarter of the interest is added back to profit, to the extent that the add-backs exceed an allowance. Because creditors rank ahead, debt capital is usually cheaper than equity; as indebtedness rises, however, equity providers demand a higher return.

Debt capital and equity: leverage, risk and subordination

As long as the return on total capital, that is, the return on all capital employed, exceeds the interest rate on debt capital, additional debt capital increases the return on equity (leverage effect). If the return falls below the interest rate, the effect reverses. Because interest and repayments fall due regardless of results, debt capital also increases the risk of illiquidity (Section 17 of the German Insolvency Code, InsO). If assets no longer cover debts, that alone is not yet over-indebtedness within the meaning of Section 19 InsO. It must also be the case that continuation of the business over the next twelve months is not more likely than not.

In insolvency, shareholder loans are satisfied only after the other creditors (Section 39 (1) no. 5 InsO); their repayment in the last year before the insolvency filing can be challenged. Exceptions include non-managing shareholders holding no more than 10%. With a qualified subordination agreement (qualifizierter Rangrücktritt), a creditor additionally steps back behind all other creditors. Its claim thus becomes a subordinated liability, which is disregarded in the over-indebtedness test but remains debt capital in the commercial balance sheet.

Key figures for debt capital

• Debt capital ratio: debt capital divided by total assets × 100%, the counterpart to the equity ratio.
• Return on debt capital (cost of debt): interest expense divided by debt capital; relative to interest-bearing debt capital, the average interest rate the company pays.
• Static debt ratio: debt capital divided by equity.
• Net financial debt (net debt): interest-bearing financial liabilities such as bank and shareholder loans less cash and cash equivalents.
• Dynamic debt ratio: in loan agreements usually net financial debt divided by EBITDA (leverage). Classic balance sheet analysis divides it by a cash flow and thereby obtains the notional debt repayment period in years.
• Interest cover and debt service cover: EBIT or EBITDA in relation to interest expense, or available cash flow in relation to debt service from interest and repayments, respectively.

Debt capital in a company acquisition

Company acquisitions are usually negotiated on a cash-free, debt-free basis, that is, as if the buyer were taking over the company without debts and without bank balances. The buyer values the operating business, the enterprise value, and deducts net financial debt and debt-like items. The result is the equity value, which the sellers are entitled to for their shares. Trade payables and most operating provisions, by contrast, belong to working capital. The main point of negotiation is the boundary: tax provisions for past years, pension provisions, accrued interest, lease liabilities and sale-related bonuses are treated as debt-like depending on the outcome of the negotiations.

Bank loans regularly contain clauses for a change of control, that is, the sale of the majority of the shares, which give the bank a right of termination. They are therefore usually repaid at completion. Economically, the repayment is at the sellers' expense, because the loans have already been deducted from the enterprise value. Shareholder loans are either repaid or sold along with the shares to the buyer at nominal value. Investors in a funding round make sure that new equity flows into growth, not into repaying old debts.

Worked example: calculating debt capital and deriving the purchase price

A GmbH reports total assets of EUR 6.0 million. Equity amounts to EUR 1.8 million. On the equity and liabilities side there are also provisions of EUR 0.5 million, of which EUR 0.2 million are tax provisions for past years. The liabilities consist of a bank loan of EUR 2.0 million, a shareholder loan of EUR 0.6 million, trade payables of EUR 0.7 million and other liabilities of EUR 0.4 million. Cash and cash equivalents amount to EUR 0.9 million, EBITDA to EUR 1.0 million.

• Debt capital: 0.5 + 2.0 + 0.6 + 0.7 + 0.4 = EUR 4.2 million; check: 1.8 + 4.2 = EUR 6.0 million total assets
• Debt capital ratio: 4.2 / 6.0 = 70%
• Static debt ratio: 4.2 / 1.8 = 2.33
• Net financial debt: 2.0 + 0.6 minus 0.9 = EUR 1.7 million
• Dynamic debt ratio: 1.7 / 1.0 = 1.7
• Purchase price at an agreed enterprise value of EUR 8.0 million: 8.0 minus 1.7 net financial debt minus 0.2 debt-like tax provisions = EUR 6.1 million equity value
• Sale of the shareholder loan along with the shares at nominal value: the buyer pays EUR 6.1 million for the shares and EUR 0.6 million for the loan receivable, so that EUR 6.7 million reaches the sellers
• Repayment of the bank loan at completion: EUR 2.0 million to the bank. The buyer thus spends a total of 6.7 + 2.0 = EUR 8.7 million and takes over EUR 0.9 million of cash, so EUR 7.8 million net. Together with the tax liability of EUR 0.2 million, which stays in the company and is paid later, this comes exactly to the agreed enterprise value

Every item treated as debt-like reduces the equity value by the same amount. For tax purposes, the split between shares and loan is not a matter of indifference to the sellers, because the repayment of a loan is treated differently from a capital gain on disposal.

Distinctions: equity, liabilities and mezzanine capital

• Equity: liable capital of the shareholders with a claim to profit and liquidation proceeds, but without a fixed repayment claim.
• Liabilities: debts that are certain as to their existence and amount. They are one part of debt capital, alongside provisions.
• Mezzanine capital: subordinated financing with equity-like features, the classification of which changes depending on the viewpoint: commercial balance sheet, bank or insolvency law.

Common mistakes

• Financing long-term needs with short-term capital. If an investment is paid for through the overdraft facility, the bank decides on the financing with every renewal.
• Comparing only the interest rate. Fees, repayment profile, security and loan conditions often have a stronger effect than a difference of half a percentage point.
• Unlimited personal guarantees. With a guarantee, shareholders or managing directors are personally liable; amount, term and release should be clarified before signing.
• Confusing debt service with expense. Only the interest reduces profit; repayments are therefore missing in plans that only roll forward the income statement.
• Not reviewing loan agreements for the exit. Change of control clauses, consent requirements for share transfers and prepayment penalties affect the timetable and purchase price of a sale.

Frequently asked questions

Is a shareholder loan equity or debt capital?

Debt capital under commercial law, because there is a repayment claim. In insolvency it ranks behind other claims, and with a qualified subordination agreement it is disregarded in the over-indebtedness test. Banks therefore often count it as economic equity. In the purchase price calculation of a company sale, however, it counts towards net financial debt.

Are provisions debt capital?

Yes. They represent obligations whose amount or due date is still uncertain. In the purchase price calculation, they are allocated to working capital or to debt-like items depending on their nature.

How much debt capital can a growth company bear?

There is no fixed limit. What matters is whether operating cash flow can carry interest and repayments even in a weak year. Companies with predictable recurring revenue can take on more debt capital than those with highly fluctuating project business.

Why do trade payables not count towards net financial debt?

Because they arise from day-to-day business and are constantly replaced by new deliveries. They belong to working capital, which is taken into account in the purchase agreement through a separate mechanism.

The Roemer Capital view

Whether part of the capital requirement can sensibly be covered with debt capital, for example with venture debt or promotional loans, is something Roemer Capital clarifies before every funding round. In the financial model, it calculates how interest and repayments change the runway. Debt capital complements a round when predictable revenue can carry the debt service; financing ongoing losses permanently is not its purpose.

Before a process, Roemer Capital reviews existing loan agreements to see whether change of control clauses, consent requirements or conditions stand in the way of a funding round or a sale. Net financial debt and disputed debt-like items are quantified early, so that the bridge from enterprise value to purchase price is not first created in the negotiation.