Leveraged Recapitalization

What Is Leveraged Recapitalization?

A leveraged recapitalization is a corporate finance transaction where a company changes its capitalization structure by supplanting the majority of its equity with a package of debt securities comprising of both senior bank debt and subordinated debt. A leveraged recapitalization is likewise alluded to as leveraged recap. As such, the company will borrow money to buy back shares that were recently issued, and reduce the amount of equity in its capital structure. Senior directors/workers might receive extra equity, to adjust their interests to the bondholders and shareholders.

Typically, a leveraged recapitalization is utilized to prepare the company for a period of growth, since a capitalization structure that leverages debt is more beneficial to a company during growth periods. Leveraged recapitalizations are likewise well known during periods when interest rates are low since low interest rates can make borrowing money to pay off debt or equity more affordable for companies.

Leveraged recapitalizations contrast from leveraged dividend recapitalizations. In dividend recapitalizations, the capital structure stays unchanged in light of the fact that main a special dividend is paid.

Figuring out Leveraged Recapitalization

Leveraged recapitalizations have a comparative structure to that employed in leveraged buyouts (LBO), to the degree that they essentially increase financial leverage. Yet, dissimilar to LBOs, they might remain publicly traded. Shareholders are more averse to be influenced by leveraged recapitalizations as compared to new stock issuances since giving new stocks can weaken the value of existing shares, while borrowing money doesn't. Thus, leveraged recapitalizations are viewed all the more well by shareholders.

They are some of the time utilized by private equity firms to exit a portion of their investment early or as a source of refinancing. What's more, they have comparative impacts to leveraged buybacks except if they are dividend recapitalizations. Utilizing debt can give a tax safeguard — which could offset the extra interest expense. This is known as the Modigliani-Miller theorem, which shows that debt gives tax benefits not open by means of equity. Furthermore, leveraged recaps can increase earnings per share (EPS), return on equity and the price to book ratio. Borrowing money to pay off more established debts or buy back stock likewise assists companies with keeping away from the opportunity cost of doing as such with earned profits.

Like LBOs, leveraged recapitalizations give incentives to management to be more focused and work on operational productivity, to meet bigger interest and principal payments. They are frequently are joined by a restructuring, in which the company auctions assets that are repetitive or as of now not a strategic fit to reduce debt. Nonetheless, the peril is that incredibly high leverage can lead a company to lose its strategic concentration and become considerably more powerless against surprising shocks or a recession. In the event that the current debt environment changes, increased interest expenses could compromise corporate feasibility.

History of Leveraged Recapitalization

Leveraged recapitalizations were especially famous in the late 1980s when by far most of them were utilized as a takeover defense in mature industries that don't need substantial continuous capital expenditures to stay competitive. Expanding the debt on the balance sheet, and in this way a company's leverage acts as a shark repellant protection from hostile takeovers by corporate plunderers.