The debt-to-equity ratio: Definition and calculation

Debt-to-equity ratio measures a company’s debt relative to shareholders’ equity, showing financial risk and capital structure at a glance.

In this article, you’ll learn about the debt-to-equity ratio, including how to calculate it, what it signals to investors, and how you can use it to make smart decisions about funding your company’s growth.

What is the debt-to-equity ratio?

The debt-to-equity (D/E) ratio is a financial metric that compares a company’s total debt to the value of its total shareholders' equity. It’s a quick way to see how much borrowed money funds your company versus how much capital you and your investors have put in. This ratio gives a snapshot of your company's financial leverage and its reliance on debt.

Think of it like a mortgage on a personal home. The loan from the bank is your debt, while your down payment and any principal you've paid off represent your equity. The D/E ratio for your house would show how much of its value is still owed to the bank compared to how much you truly own.

In a business context, this concept is called financial leverage. It’s a way of measuring how much a company relies on borrowed money to operate and grow. Understanding this balance is a key part of managing your company's financial health and telling a clear story to investors.

Why the D/E ratio matters for fundraising

As a founder, you should view the D/E ratio as more than just an accounting metric. It’s a key part of the financial story you tell investors when you're fundraising, and it's a number they will almost certainly look at. For instance, in PE-backed companies, nearly 52% of performance conditions on management equity grants are linked to an investor’s financial return, such as MOIC or IRR, according to a 2024 analysis of Carta data.

During the due diligence process, potential investors will look closely at this ratio to understand your company's risk profile. The balance between your debt and equity signals how you approach growth, manage your finances, and think about your capital structure. It tells them how much risk your company has taken on through borrowing.

A messy or confusing financial picture can quickly erode an investor's confidence. By understanding and being able to speak to your company's D/E ratio, you show that you're a serious founder who is prepared for institutional investment and has a firm grasp on the company's financial standing.

How to calculate your D/E ratio

Calculating your D/E ratio is straightforward, and you don't need to be a finance expert to do it. The most important part is making sure you use the right numbers as inputs. The two figures you'll need can be found on your company's balance sheet, which is one of the core financial statements that tracks assets, liabilities, and equity at a specific point in time.

The debt-to-equity ratio formula

The formula itself is simple: Total Liabilities ÷ Shareholders' Equity.

In this formula, total liabilities represent everything your company owes to others, from vendor payments to bank loans. Shareholders' equity is the company's net worth on its books, or the value that would be left for the owners if all debts were paid off.

What counts as debt for a startup?

For a startup, the "liabilities" or "debt" part of the equation can include more than just a traditional loan from a bank. It's helpful to think about these obligations in two categories: short-term debt and long-term debt. Getting this part right is key to an accurate calculation.

• Short-term debt: These are financial obligations that are due within one year.

• Accounts payable, which is the money you owe to your vendors or suppliers for goods and services you've already received.

  • Balances on company credit cards that need to be paid off.
  • The current portion of any long-term loans, meaning the principal payments you're scheduled to make in the next 12 months.

• Long-term debt: These are obligations that are due more than a year from now.

• Venture debt, a type of loan specifically for venture-backed companies that often complements an equity round.

  • Loans from the Small Business Administration (SBA) or other commercial banks.
  • Convertible notes, which are a common form of early-stage funding. Before these notes convert into equity, they are treated as debt on your balance sheet.

What counts as shareholders' equity?

Shareholders' equity is the value of your business that belongs to its owners, including founders, employees, and investors, after all debts have been paid. The basic formula for it is Total Assets minus Total Liabilities. It represents the capital invested in the company plus any profits that have been retained over time.

This number is directly tied to your cap table. The value of all the stock your company has issued, from the initial founder shares to the preferred stock sold to venture capitalists, forms the foundation of your shareholders' equity.

To get an accurate figure for shareholders' equity, you need a perfect, up-to-the-minute record of who owns what. An error-prone spreadsheet can lead to the wrong calculation and a misunderstanding of your company's financial position.

To help you get started, you can download our free cap table template to track ownership and equity distribution accurately from day one.

High vs. low debt-to-equity ratio

Maintaining a good debt-to-equity ratio is crucial because it signals a company’s financial health and risk profile to investors and lenders. While debt-to-equity ratios can vary by industry, company size, and economic conditions, some general guidelines apply:

• Low D/E ratio (<1.0): Indicates a conservative approach with greater reliance on equity financing. This carries a lower risk but can limit growth opportunities.

• Moderate D/E ratio (1.0–2.0): Suggests balanced capital structure (amount of debt vs. equity), supporting sustainable growth while keeping financial risk in check.

• High D/E ratio (>2.0): Implies a heavier reliance on debt financing, which is higher risk but more likely to generate returns.

How investors analyze your D/E ratio

Investors rarely look at the D/E ratio in a vacuum. You can expect them to use it as a starting point to understand the context of your business and your financial strategy. A particular D/E ratio isn't automatically good or bad; its meaning depends on your company's stage, industry, and growth plans.

Think of your D/E ratio as a conversation starter. A high or low number will prompt an investor to ask "why?" and dig deeper into your financial decisions. The analysis of your D/E ratio is all about understanding the story behind the number and being able to explain it with confidence.

What is a good D/E ratio for a startup?

There is no single "good" D/E ratio that applies to all companies, especially for startups where the financial picture changes rapidly. Instead, investors interpret the ratio based on what's typical for a company at your stage and what it signals about your strategy.

• A low ratio: A low D/E ratio is very common for early-stage startups, and this is a direct result of how they are typically funded. Instead of taking on traditional debt, most early companies raise capital through other means. For example, recent data on seed round structures shows that only 10% of seed rounds were financed using convertible notes, which function as debt. The vast majority of companies used either simple agreements for future equity (SAFE) (64%) or priced equity rounds (27%). This strong preference for non-debt financing instruments is a key reason why you'll typically see a low D/E ratio at this stage.

• A moderate ratio: This might be seen in a growth-stage company that has strategically taken on venture debt. This can be a positive signal, showing a sophisticated approach to funding expansion without giving up more ownership through dilution.

• A high ratio: A high ratio in your term sheet, like a liquidation preference above 1x, can be a major red flag for investors. While these terms can feel like a necessary compromise when fundraising is tough, they're not as common as you might think. Even at their recent peak, deals with non-standard liquidation preferences only accounted for 3.7% of all funding rounds in Q2 2024. Accepting such a term can signal distress to future investors and create a complicated cap table that makes later rounds much harder to close.

D/E ratio benchmarks by industry

What's considered a normal level for D/E also depends heavily on a company's industry and business model. Some industries are capital-intensive and naturally rely more on debt, while others are built almost entirely on equity investment. Understanding where your company fits helps you frame your financial story.

The strategic trade-off: Using debt for growth

As a founder, it's helpful to think of debt not as a sign of weakness, but as a strategic tool that can be used for smart growth. The decision to use debt or equity to fund your company involves a core tradeoff that every founder must consider.

When you raise money through equity financing, you are selling a piece of your company and diluting the ownership of existing shareholders. With debt financing, you borrow money that you have to pay back with interest, but you get to keep more of your ownership.

In some situations, using debt can be a powerful way to accelerate growth. By borrowing capital, you can potentially increase the overall value of your company. Taking on strategic debt, like a bridge round, gives you the runway to make operational improvements that can pay off later. For instance, some experts advise that founders who take on bridge financing should use the funds to invest in marketing and product improvements. This approach positions them to better justify their valuation when they go to raise their next round of capital.

Managing your capital structure for the next round

When you're preparing to raise your next round of funding, be proactive, not reactive, about your capital structure. This means thinking ahead about how different funding options will affect your company's finances and ownership structure.

Before you start talking to investors, you need to understand how raising money through new SAFEs, convertible notes, or a priced equity round will impact your ownership, dilution, and your D/E ratio.

This is where planning tools become incredibly valuable. Carta's Scenario Modeling is a professional-grade tool that lets you do exactly this. It allows you to model the impact of different financing instruments on your cap table, so you can see the consequences of each choice and walk into investor negotiations with a clear understanding and confidence.

Frequently asked questions about the D/E ratio

What does a D/E ratio of 1.5 mean?

A D/E ratio of 1.5 means that for every one dollar of equity a company has, it has one dollar and fifty cents of debt. This indicates that the company is using more debt than equity to finance its assets.

Can a company have a negative D/E ratio?

Yes, a company can have a negative D/E ratio if its total liabilities are greater than its total assets, resulting in negative shareholders' equity. This is often a sign of significant financial distress.

How does venture debt affect the D/E ratio?

Taking on venture debt increases a company's total liabilities, which in turn raises its D/E ratio. Startups often use this strategy to fund growth between equity financing rounds without immediately diluting ownership.