Recapitalization

What is Recapitalization?

Recapitalization refers to the process of reconstructing a firm’s debt and equity ratio. This is usually done to balance out the firm’s financial Capital structure. This is a popular strategy to strengthen the Financial Structure and the firm must look forward to changing its debt-to-equity-ratio to accomplish this goal. How can the firm do this? Well, it will have to add more debt or more equity to its capital.

When a firm’s debt goes down in proportion to its equity, its leverage reduces. Moreover, its Earnings per shares (EPS) will also decrease. However, on the bright side, its shares would carry less risk since the firm has fewer debt obligations. This would require interest payment and return on principal upon maturity. Remember that without debt, a firm can return more of profits and money to shareholders.

Why Should One Consider Recapitalization?

Here are 5 key reasons why a firm should consider recapitalization

1. Protection Against Takeover

One of the basic factors that are motivation enough for a firm to consider recapitalization is the risk of a hostile takeover. Recapitalization could help the firm shield itself. The firm may make a decision to issue more debt and make it less attractive to those who wish to take over it.

2. Reduction of Financial Obligation

The firm may decide to consider recapitalization in order to reduce its financial Obligation. Higher levels of debt compared to equity would mean bigger interest payments. By taking up trading in debt for equity, a firm can reduce the debt level. This in turn will reduce the amount of interest it pays to creditors. The firm can then enjoy improved financial health.

3. Minimising taxes

Another major benefit a firm can enjoy is a reduction in Taxes. However, this depends on the tax rules in the country of origin.

4. Fall in share price

Recapitalization also helps in keeping share prices constant. If a firm notices that the prices of its shares are falling, it can decide to swap equity for debt and elevate the stock price.

5. For Venture capitalists

Firms can consider recapitalization to provide venture capitalists with the option of an exit strategy.

Recapitalization and Government

Governments also take part in cases of mass recapitalization of the country’s banking sector in times of financial turbulence. If a national Bank’s solvency and liquidity become a matter of concern, the government steps in. Did you know the government can buy back shares to avail the upper hand in the interest of a firm that is important to the development of a country’s Economy? This is done through the process of nationalization. This is another form of recapitalization.