What Is Recapitalization?
Recapitalization is the most common way of restructuring a company's debt and equity combination, frequently to settle a company's capital structure. The interaction mostly includes the exchange of one form of financing for another, for example, eliminating [preferred shares](/inclination shares) from the company's capital structure and supplanting them with bonds.
Figuring out Recapitalization
Recapitalization is a strategy a company can use to work on its financial stability or update its financial structure. To achieve this, the company must change its debt-to-equity ratio by adding more debt or greater equity to its capital. There are many motivations behind why a company might consider recapitalization including:
- A fall in share price
- To safeguard itself against a hostile takeover
- To reduce financial obligations and limit taxes
- To give venture capitalists with an exit strategy
At the point when a company's debt diminishes in relation to its equity, it has less leverage. Its earnings per share (EPS) ought to diminish following the change. Be that as it may, its shares would be gradually safer since the company has less debt obligations, which require interest payments and return of principal upon maturity. Without the requirements of debt, the company can return a greater amount of its profits and cash to shareholders.
Motivations to Consider Recapitalization
A few factors propel a company to recapitalize. A company might choose to involve it as a strategy to safeguard itself against a hostile takeover. The target company's management might choose to issue more debt to make it less appealing to the possible acquirer.
Another explanation might be to reduce its financial obligations. Higher debt levels compared to equity means higher interest payments. By trading in debt for equity, the company can reduce the level of debt and, subsequently, the amount of interest it pays to its creditors. This, thusly, works on the company's overall financial prosperity.
Besides, recapitalization is a practical strategy to assist with keeping share prices from dropping. Assuming a company observes that its shares are declining in value, it might choose to swap equity for debt to push the stock price back up.
A few companies may likewise utilize recapitalization to limit their tax payments, execute a exit strategy for venture capitalists, or rearrange themselves during a bankruptcy. Companies frequently utilize this as a method for enhancing their debt-to-equity ratio to improve liquidity.
Types of Recapitalization
Companies can swap debt for equity or vice versa for some reasons. An illustration of equity supplanting debt in the capital structure is the point at which a company issues stock to buy back debt securities, expanding its extent of equity capital compared to its debt capital. This is called an equity recapitalization.
Debt investors require routine payments and a return of principal upon maturity, so a swap of debt for equity assists a company with keeping up with its cash and utilize the cash created from operations for business purposes, reinvestment, or capital returns to equity holders.
Then again, a company might issue debt and utilize the cash to buy back shares or issue dividends, really recapitalizing the company by expanding the extent of debt in the capital structure. One more benefit of assuming more debt is that interest payments are tax-deductible while dividends are not. By paying interest on debt securities, a company can diminish its tax bill and increase the amount of capital returned altogether to both debt and equity investors.
Governments might buy back shares to get a controlling interest in a company important to a country's economy through nationalization — one more form of recapitalization.
Governments likewise participate in the mass recapitalization of their nations' banking sectors during times of financial crisis and when the solvency and liquidity of banks and the greater financial system come into question. For instance, the U.S. government recapitalized the nation's banking sector with different forms of equity to keep the banks and the financial system dissolvable and keep up with liquidity through the Troubled Asset Relief Program (TARP) in 2008.
- A portion of the reasons a company might consider recapitalization remember a drop for its share price, to shield against a hostile takeover, or bankruptcy.
- The purpose of recapitalization is to settle a company's capital structure.
- Recapitalization is the restructuring of a company's debt and equity ratio.