Recapitalization is a process in which the amount of debt and assets of a particular entity are rearranged in order to meet a financial goal. The goal may be an attempt to limit the amount of tax owed on assets in hand, or as part of a reorganization to avoid bankruptcy. While the idea of recapitalization is normally associated with businesses, the same general concept can be applied to non-profit organizations, financial institutions such as banks or mortgage companies, and even to individuals.
There are several reasons why recapitalization may be an attractive option. With companies that sell goods and services to the general public, one motivation would be to strengthen the business’s financial picture in anticipation of an expansion. This can include something as simple as replacing preferred stock options with bond issues in order to minimize the tax burden. By restructuring the relationship between debt and the equity currently built into the company, it may be possible to reduce future obligations and divert those funds directly into expansion projects that will make the company stronger over time.
A business may also undergo recapitalization as a means of avoiding bankruptcy. With this application, the way the company spends money is altered so that the business can secure funds to keep operating until it is possible to realize a net profit once again. This may mean trimming expenditures in some areas while increasing them in others, maintaining a lower amount of inventory in order to lower the overall tax burden, and any other strategy that will allow the business to honor its current debt obligations.
Banks and other types of financial institutions may utilize the process of recapitalization. A bank recapitalization may occur when the entity acquires or merges with another similar entity. The collective resources of the new entity, as well as the collective liabilities, are reorganized in order to place the new bank in the best financial situation possible. The recapitalization of banks can also take place in an effort to resist a takeover attempt, or to avoid a potential failure or severe cutback in operations.
With any type of recapitalization plan, it is extremely important to have specific goals in mind. To reach those goals, a workable plan will include the establishment of a series of action items that will help the entity reach those goals in logically progressive stages. Those same action items will also provide a system of checks and balances that allow the reorganization process to be evaluated and adjusted if necessary.
