corporate finance Corporate finance is an area of finance that deals with the sources of funding, and the capital structure of businesses, the actions that managers take to increase the Value investing, value of the firm to the shareholders, and the tools and analy ...

, a leveraged recapitalization is a change of the company's

capital structure In corporate finance, capital structure refers to the mix of various forms of external funds, known as capital, used to finance a business. It consists of shareholders' equity, debt (borrowed funds), and preferred stock, and is detailed in the ...

, usually substitution of debt for equity.

Overview

Such recapitalizations are executed via issuing bonds to raise money and using the proceeds to buy the company's stock or to pay dividends. Such a maneuver is called a

leveraged buyout A leveraged buyout (LBO) is the acquisition of a company using a significant proportion of borrowed money (Leverage (finance), leverage) to fund the acquisition with the remainder of the purchase price funded with private equity. The assets of t ...

when initiated by an outside party, or a leveraged recapitalization when initiated by the company itself for internal reasons. These types of recapitalization can be minor adjustments to the capital structure of the company, or can be large changes involving a change in the power structure as well. Leveraged recapitalizations are used by privately held companies as a means of refinancing, generally to provide cash to the shareholders while not requiring a total sale of the company. Debt (in the form of bonds) has some advantages over equity as a way of raising money, since it can have tax benefits and can enforce a cash discipline. The reduction in equity also makes the firm less vulnerable to a

hostile takeover In business, a takeover is the purchase of one company (law), company (the ''target'') by another (the ''acquirer'' or ''bidder''). In the UK, the term refers to the acquisition of a public company whose shares are publicly listed, in contrast t ...

. Leveraged recapitalizations can be used by public companies to increase

earnings per share Earnings per share (EPS) is the monetary value of earnings per outstanding share of common stock for a company during a defined accounting period, period of time, often a year. It is a key measure of corporate profitability, focusing on the inte ...

. The Capital structure substitution theory shows this only works for public companies that have an earnings yield that is smaller than their after-tax interest rate on corporate bonds, and that operate in markets that allow share repurchases. There are downsides, however. This form of recapitalization can lead a company to focus on short-term projects that generate cash (to pay off the debt and interest payments), which in turn leads the company to lose its strategic focus.U.C. Peyer and A. Shivdasani, "Leverage and Internal Capital Markets: Evidence from Leveraged Recapitalizations", ''Journal of Financial Economics'' Volume 59, Issue 3, March 2001, Pages 477-515
Available free online
. According to these authors, leveraged companies increased their debt-to-capital ratio from 17% to 50% in a span of 12 years. Also, if a firm cannot make its debt payments, meet its

loan covenant A loan covenant is a condition in a commercial loan In finance, a loan is the tender of money by one party to another with an agreement to pay it back. The recipient, or borrower, incurs a debt and is usually required to pay interest for t ...

s or rollover its debt it enters

financial distress Financial distress is a term in corporate finance used to indicate a condition when promises to creditors of a company are broken or honored with difficulty. If financial distress cannot be relieved, it can lead to bankruptcy. Financial dist ...

which often leads to

bankruptcy Bankruptcy is a legal process through which people or other entities who cannot repay debts to creditors may seek relief from some or all of their debts. In most jurisdictions, bankruptcy is imposed by a court order, often initiated by the deb ...

. Therefore, the additional debt burden of a leveraged recapitalization makes a firm more vulnerable to unexpected business problems including recessions and

financial crises A financial crisis is any of a broad variety of situations in which some financial assets suddenly lose a large part of their nominal value. In the 19th and early 20th centuries, many financial crises were associated with Bank run#Systemic banki ...

References

External links

"Recapitalization" at Investorwords.com
{{DEFAULTSORT:Leveraged Recapitalization Business terms Corporate finance Private equity

Overview

See also

References

External links