What is Recapitalization?

Recapitalization is a financial strategy of readjustment of a company's capital structure by exchanging one type of financing for other. It is generally done with an objective of optimizing leverage and stabilizing the capital finance structure. The restructuring can be done by altering the debt-equity ratio of the company. It replaces one form of finance with another. For example, bonds can replace the preferred shares during this restructuring. A company can buy back its equity shares by issuing debt.

How Does Recapitalization Work?

A company may undergo a recapitalization process for a number of reasons, including a drastic fall in stock price or a bankruptcy. It can also be done to prevent a hostile takeover, reduce the company's debt burden, or to implement an exit strategy for venture capitalists. One of the most common methods of recapitalization is a leveraged recapitalization. A company issues new bonds and buys back its own shares with the money earned from those bonds. A company often opts for this type of recapitalization on the occasions of a steep decline in the price of the shares of the company. It is done to increase the per share price of the company by reducing the number of outstanding shares in the market. Issuing debt in order to buy back the shares increases the debt-to-equity ratio in the capital structure. While funds used to pay dividends are taxable, the interest payments of debts are tax deductible. Another method of restructuring is the equity recapitalization process. In this method, equity stocks are issued for raising money. Then, those funds are used for buying back the debt securities. This recapitalization process helps to reduce the debt-to-equity ratio of a company. A higher debt-to-equity ratio puts an extra burden on a company's finances, as a company needs to pay interest on its debt securities. The high debt-to-equity ratio also increases the risk level of a company and makes it less lucrative to the investor. So, the companies opt for this type of recapitalization for reducing their debt burden. Nationalization is another type of recapitalization. It happens when the government takes part in a recapitalization process either to prevent the bankruptcy of the business or to obtain a controlling interest. In this process, the government of the nation where the company is situated buys a significant number of shares of the company. It may be done to protect an institution or company that is considered to be important for the country's economy from insolvency and liquidity. It may also be done by a government to take over the assets of a large company, (especially a foreign company) operating in the country.