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The word recapitalization means to restructure the financing mix of the companyâs sources of funds, i.e., the debt and the equity mix. This strategy is often implemented in the wake of making the capital structure most stable and cost-effective. It predominantly involves the exchange of one source of funds for another, i.e., debt for equity, or equity for debt. For example, redeeming the bonds earlier issued by raising funds from issuing equity shares.
This phenomenon can be undertaken for a number of reasons, some of which are defending a hostile takeover, tax management or forming an exit strategy. Also, companies take this measure to diversify their debt-to-equity ratio so as to gain a better liquidity position. The strategy is also used by corporations across the globe to restrict a continuous fall in the share price of the company. To compensate for this loss or to restrict this fall, the company raises funds through the issuance of bonds and then utilize those funds for buying back the shares from the open market resultantly reducing the number of outstanding securities, ultimately pushing the prices of the stock towards upside on account of the micro scenarios. Also, if the company is of a belief that the existing Debt-Equity mix is proving to be a problem for the company in terms of the overleveraging etc. then the recapitalization can solve such Impending concerns. In such cases, the company can raise equity and then can service its debt, hence reducing its financial leverage.
However, in the case to avoid a hostile takeover bid the company can use a different strategy. In such cases, the company can mount its balance sheet with additional borrowings, hence making itself less attractive for a hostile takeover plan. And hence, when a company seems to be overburdened with the debt and looks to be carrying a lot of financial risks, then it will portray itself to be way less attractive to the bidder or the potential acquirer. To achieve this, the company will issue fresh debt and will buy back its shares.
Also, the recapitalization is used by the organizations as a part of its reorganization strategy if the company is under the threat of bankruptcy. A fruitful recapitalization is a critical aspect for an insolvent company to endure the course of liquidation. Any changes which are affected in the capital structure must please all the stakeholders in the process, which involves the bankruptcy court, financial & operational creditors, and investors at large. If effective, the corporation assumes a novel capital structure which aids it to carry on with its business activities and hence avoid liquidation.
As regards, the lasting impacts of reorganization, an optimization of the debt profile of the company will lead the organization to become less risky since it would be having lower repayment obligation and debt servicing requirements. Hence with the optimization of leverage on its balance sheet, the company would be more capable of providing more returns and cash to its equity shareholders.
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