What Is Leveraged Recapitalization?

There are many different ways for corporations, both public and private, to raise money in the capital markets. Reasons behind any type of money-raising transaction could also be led by one or more potential drivers. Primarily, companies can raise money in the debt capital markets and the equity capital markets. A leveraged recapitalization is when an issuer turns to the debt markets to sell bonds and uses the proceeds to buy additional equity shares or distribute equity dividends to investors.

Changes in a company's capital structure occur following a leveraged recapitalization. This structure is a financial snapshot of the issuing company's equity and debt mix, including long-term and short-term debt obligations in addition to common and preferred shares of stock. This synopsis is an indication of how a business finances its operations, including internal growth and expansion initiatives.

At the surface, a leveraged recapitalization may seem counterproductive. Turning to the debt markets to repay debt, buy company stock, or reward investors from proceeds gained by debt instead of using earned profits may be driven by a number of incentives, however. For instance, the economic environment may be that interest rates on borrowing money are low. During this type of cycle, money is thought to be cheap, and a leveraged recapitalization may be the best option.

Also, incorporating debt onto a balance sheet might introduce greater financial discretion to the company because ongoing payments must be made to debt holders consistently. Other benefits may be tax related, depending on the region in which a leveraged recapitalization occurs. By increasing debt as opposed to equity, an issuing company avoids diluting the shares of existing stockholders and also reduces the chances that majority shareholders might attempt to shake up operations somehow. Industry participants might argue that the pitfalls of using a leveraged recapitalization include limiting growth plans at a company to the here and now as opposed to taking a longer-term view.

If a third-party entity initiates a recapitalization on behalf of a corporation, the deal is known as a leveraged buyout. In such a transaction, the private equity firm will typically invest some of its own capital into the deal but also turn to the debt capital markets to finance a large portion of the transaction with debt. As a result of a leveraged buyout deal, a company may shift from being a publicly traded entity to the privately-held markets for a number of years, and there may be a reorganization in the management regime at the target company.