What is Leveraged Recapitalization
A leveraged recapitalization, often called a leveraged recap, is a corporate finance transaction in which a company replaces the majority of its equity with a package of debt securities consisting of both senior bank debt and subordinated debt. Senior managers/employees may receive additional equity, in order to align their interests with the bondholders and shareholders.
BREAKING DOWN Leveraged Recapitalization
Leveraged recapitalizations have a similar structure to that employed in leveraged buyouts (LBO), to the extent that they significantly increase financial leverage. But unlike LBOs, they may remain publicly traded.
They are sometimes used by private equity firms to exit some of their investment early, or as a source of refinancing. And they have similar impacts to leveraged buybacks, unless they are dividend recapitalizations. Using debt can provide a tax shield – which might outweigh the extra interest expense. And they increase earnings per share (EPS), return on equity and the price to book ratio.
Leveraged recapitalizations were especially popular in the late 1980s, when the vast majority of them were used as a takeover defense in mature industries that do not require substantial ongoing capital expenditures to remain competitive. Increasing the debt on the balance sheet, and thus a company’s leverage, acts as a shark repellant protection from hostile takeovers by corporate raiders.
Like LBOs, leveraged recapitalizations provide incentives for management to be more disciplined and improve operational efficiency, in order to meet larger interest and principal payments. They are often are accompanied by a restructuring, in which the company sells off assets that are redundant or no longer a strategic fit in order to reduce debt. However, the danger is that extremely high leverage can lead a company to lose its strategic focus and become much vulnerable to unexpected shocks or a recession.