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.

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.

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.

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.

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. Shareholders' equity is the company's net worth on its books.

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 helps 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.
  • Balances on company credit cards.
  • The current portion of any long-term loans.

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

  • Venture debt.
  • Loans from the Small Business Administration (SBA) or other commercial banks.
  • Convertible notes.

What counts as shareholders' equity?

Shareholders' equity is the value of your business that belongs to its owners. The basic formula for it is Total Assets minus Total Liabilities.

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. Some general guidelines apply:

• Low D/E ratio (<1.0): Indicates a conservative approach.
• Moderate D/E ratio (1.0–2.0): Suggests balanced capital structure.
• High D/E ratio (>2.0): Implies a heavier reliance on debt financing which is higher risk but can 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.

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.

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. 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: Common for early-stage startups.
• A moderate ratio: Seen in a growth-stage company that has strategically taken on venture debt.
• A high ratio: Can be a major red flag for investors.

D/E ratio benchmarks by industry

The strategic trade-off: Using debt for growth

When you raise money through equity financing, you sell a piece of your company and dilute ownership. With debt financing, you borrow money but keep more ownership.

Managing your capital structure for the next round

When you're preparing to raise your next round of funding, understand how raising money will impact your ownership, dilution, and your D/E ratio.

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 dollar of equity a company has, it has one dollar and fifty cents of debt.

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.

How does venture debt affect the D/E ratio?

Taking on venture debt increases a company's total liabilities, which raises its D/E ratio. Startups often use this strategy to fund growth between equity financing rounds.