Companies can change their capital through the financial approach of recapitalization. The procedure is reconfiguring the debt-to-equity level of the company to serve some purposes, like a significant degree of financial stability, decreasing the cost of funding, or preparation for future growth. Recapitalization is highly beneficial to firms that are intended to rise from a weak financial position or those experiencing financial distress. Let’s explore the meaning and importance of it.
How Does Recapitalization Work?
In simple words, recapitalization is actually the alteration in the mix of debt and equity of a company. It can be done in many forms-for example, by issuance of new shares as a means of servicing debt or by issuance of new debt to be used in repurchase of equity or shares. In the long run, it aims to alter the capital structure for the better of the corporation either temporarily or permanently.
As a source of raising funds in times of financial distress, a company could raise additional debt or seek investment from private equity financiers. Another company would opt for its finances to be re-capitalized, issue more shares, and then use the revenues from such an issuance to pay down debt if it has too much debt.
Types of Recapitalization
- Equity Recapitalization: The company issues new shares to create more equity, which can either be returned to pay off debt or used to finance new ventures.
- Debt Recapitalization: The company is essentially taking on more debt, usually a share buyback or dividend payments to investors.
Such a plan is successful in making companies that intend to improve their financial soundness, lower their risk or are set to expand. Recapitalization can enable companies to increase their ratio of debt to equity, and both are either undertaken proactively in order to achieve the highest possible capital or are undertaken reactively as a way out of some kind of financial stress.
