Why do a leveraged recapitalization

All of the capital used to fund the dividend pay out or share repurchase would be in the form of either senior or mezzanine debt not equity.

The advantages and disadvantages of a leveraged recapitalization are as follows:. In the public markets, leveraged recapitalization can be used in many ways for a variety of reasons that are beneficial to the organization. For example:. Stay on top of new content from Divestopedia.

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Neutralizing the Due Diligence Grind. In simple terms, a company will borrow money i. These proceeds will then be used to repurchase shares which were previously issued and decrease the proportion of equity in the company's capital structure. Hence the term, leveraged recapitalization.

But for a negative view, see " Debtor's Prison? In the case of Sealed Air's leveraged recap HBS Case , management purposefully and successfully used the leveraged recapitalization as a watershed event, creating a crisis that disrupted the status quo and promoted internal change, which included establishing a new objective, changing compensation systems, and reorganizing manufacturing and capital budgeting processes.

This case provides an illustration of how financing decisions affect organizational structure, management decision making, and firm value.

As Sealed Air suggests, the critical feature in both kinds of recaps is whether other operating improvements are made. A key indicator of whether leverage is having the desired disciplinary effect is the post-recap balance sheet progress. When successful, the large overhang of debt service obligations galvanizes management to improve operational performance thus generating sufficient cash flows to pay down the debt.

Exchange Offers involve giving one or more classes of claimholders the option to trade their holdings for a different class of securities of the firm. Typical examples are allowing common shareholders to exchange their shares for bonds or preferred stock, or vice-versa. Exchange offers may have motivations similar to those of leveraged recapitalizations, taking advantage of free cash flows or altering management's share of control, or they may be distress-induced workouts. Most of us would suppose that nobody would elect to exchange one security for another unless the latter was more valuable than the first, giving the investor a positive return.

Since so much of the success may revolve around timing, availability of capital and industry conditions, it is wise for owners and shareholders to discuss a recapitalization opportunity with advisors who are well versed in corporate finance and understand their business objectives.

Interested in learning more about recapitalizing an ESOP as an alternative to the status quo? Flip through the SlideShare below:. A company will likely need a low debt to equity ratio to qualify for a recapitalization. Without this information, it will be very difficult to determine a premium valuation or demonstrate accurate sales projections.

In addition, a recapitalization is not a process that a company can accomplish in a few weeks or even a few months.