Re-Capitalizing Your Company
A re-capitalization occurs when a company's capital structure is changed in order to achieve a desired outcome. There are various types of re-caps with differing objectives.
Re-Capitalizing to Restructure Ownership
This type of re-capitalization can be used when a private business owner wishes to transition ownership to a different ownership group. It may or may not involve a change of owner control, and the participation of a financial sponsor such as a private equity fund. Sources of capital in these cases include debt and new equity investment with the cash being used to acquire all or part of the company owner's investment in the company. The owner's objective could be to gain liquidity, diversify investment and effect estate planning, or to transition operating management and ownership to a new group.
Re-Capitalizing to Leverage Return on Equity
This type of recapitalization involves the company borrowing money so that more debt is present in the capital structure. Prudent borrowing permits companies to reduce their tax payments as interest payments on debt are deductible from taxable income. The debt that is incurred as part of this type of re-capitalization is often used to either return cash to equity owners or to fund company growth. A simple example of this type of re- capitalization occurs when a public company buys back shares, thus reducing the equity outstanding and increasing the company's indebtedness (or reducing its cash position).
Re-Capitalizing to Manage Indebtedness
Many companies find themselves facing financial difficulties because they cannot meet the principal repayment terms of existing debt financing. This can happen during difficult industry or economic cycles, or when a business finances long term growth plans with short term debt. In these cases, new equity capital or more patiently structured forms of indebtedness are sourced to pay out debt that has matured. This can be a very expensive exercise for current equity holders as the terms of new capital can be harsh.
Re-Capitalizing to Fuel Growth
Another frequent form of recapitalization involves the company issuing stock or debt to source cash for growth. This growth capital can be invested in a variety of ways including the funding of growing accounts receivable, inventory and capital assets, the funding of expensive but valuable sales, marketing and product development, or the funding of acquisitions. Equity capital tends to be the preferred form of growth capital as it does not have the principal and interest payment features of debt. For companies generating significant positive cash flow, debt is a reasonable alternative. For these companies, private equity investors are often the catalysts to help owners achieve multiple objectives including, gaining liquidity, transitioning to younger management and providing capital to grow the business.