31 Oct Breaking Down ‘Recapitalizations’
Hundred of billions of dollars worth of recapitalizations (recaps) and restructurings are completed each and every single year around the globe – why?
As one might suspect the almighty dollar plays a hand. The two primary reasons for re-caps are:
1. To make money
2. To save money
The types and effects of such capital structure repositionings are not all that simple as you may have guessed, but we will do our best to cover and simplify some of the more popular examples below.
Debt for Equity Plan
A business can obtain a loan against assets, inventory, receivables and use the cash received to buy back shares and/or issue dividends to shareholders, effectively “recapitalizing” the company by increasing the proportion of debt in the capital structure. Why leverage up?
Since interest payments are tax deductible, a business can decrease its tax bill and increase its return on capital all in one fell swoop.
Equity for Debt Plan
Just the same, short of an out-right sale many business owners have opted to sell minority or majority equity stakes in their respective businesses and use the capital infusion to retire debt. This has the effect of both saving and making money as it can help retain cash reserves as well as free up existing cash flow from operations for re-investment, instead of ever-onerous debt interest payments.
As a general rule unless one really likes to live on the edge of a fiscal cliff with both feet dangling over, recaps are only practical for businesses that possess stable existing cash flow from operations so as to be able to service debt through the ebb and flow of up and down market cycles.
This is more often than not found in more mature companies where a better return on invested capital can be generated by investing outside of the business as opposed to back into its organic growth.
In closing, though far less glamourous and receiving far less attention than mergers and acquisitions, recapitalizations are an all important mechanism for changing a business’s capital structure without consummating a full exit.
Some special mentions which also deserve attention though technically they are reorganizations and not recapitalizations at all, although they have been used for the latter purpose in some more special cases:
Commonly referred to as Type D & G transfers, these can include transfers of control by way of a majority sale as well as spin-offs and split-offs. As an example, Company A owns most of the assets of both Company A and Company B. Company B assets are liquidated or sold off and former Company B shareholders retain ownership of Company A.
Another type of transfer, involves the oft dreaded, but sometimes strategic “b” word – bankruptcy or Chapter 11 as reorganizations are referred to. This ordinarily involves a court approved plan to divest a failing company’s assets with the proceeds being used to reduce pre-existing obligations and debts while discharging others.
As anyone who has been through the process can attest, between the initial 120 day period to file a disclosure statement/plan of reorganization, receive court approval thereof, creditor’s committee consultations, the timeline can become rather lengthy and drawn out but nevertheless usually offers shareholders the best chance to preserve at least some capital in the end.