# Recapitalization Explained: Strategies, Benefits, and Forms

> **Definition**
>
> Recapitalization is the process of restructuring a company's debt and equity mix to stabilize its capital structure often through the exchange of one form of financing for another.

## What Is Recapitalization?

Recapitalization is the process of restructuring a company’s debt and equity mixture, often to stabilize a company’s capital structure. This may involve selling shares to pay off debt, or converting [preferred shares](https://www.investopedia.com/terms/p/preference-shares.asp) to [bonds](https://www.investopedia.com/terms/b/bond.asp).

Companies may choose to recapitalize to shore up falling share prices, or to restructure their debts during a bankruptcy. During an economic crisis, governments may recapitalize companies buy buying bonds or equity, as the U.S. government did with banks during the Great Recession.

### Key Takeaways

*   Recapitalization restructures a company's debt and equity to stabilize its capital structure.  
    
*   Companies may recapitalize to prevent a hostile takeover or to stabilize share prices.  
    
*   Recapitalization can involve swapping debt for equity or vice versa, affecting the company's debt-to-equity ratio.  
    
*   Reducing debt through recapitalization can lower interest payments and financial obligations.  
    
*   Governments may use recapitalization to stabilize significant companies or banking sectors during financial crises.

![Recapitalization: Changing a company's balance of debt and equity to optimize its capital structure.](https://www.investopedia.com/thmb/v_BRChBQMDd5Lg8cZdXJ2OAMlO0=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/recapitalization.asp-final-14e58e83a9f543c58415832da736155d.png)

**

## How Recapitalization Strengthens a Company's Financial Structure

Recapitalization is a strategy that a company can use to improve its financial stability or overhaul its financial structure. To accomplish this, the company must change its [debt-to-equity (D/E) ratio](https://www.investopedia.com/terms/d/debtequityratio.asp) by adding more debt or more equity to its [capital](https://www.investopedia.com/terms/c/capital.asp). There are many reasons why a company may consider recapitalization, including:

*   A fall in share price
*   To protect itself against a hostile takeover
*   To reduce financial obligations and minimize taxes
*   To provide [venture capitalists](https://www.investopedia.com/terms/v/venturecapital.asp) with an exit strategy
*   [Bankruptcy](https://www.investopedia.com/terms/b/bankruptcy.asp)

When a company’s debt decreases in proportion to its equity, it has less [leverage](https://www.investopedia.com/terms/l/leverage.asp). Its [earnings per share (EPS)](https://www.investopedia.com/terms/e/eps.asp) should decrease following the change. But its shares would be incrementally less risky since the company has fewer debt obligations, which require [interest](https://www.investopedia.com/terms/i/interest.asp) payments and return of [principal](https://www.investopedia.com/terms/p/principal.asp) upon maturity. Without the requirements of debt, the company can return more of its profits and cash to shareholders.

## Key Reasons Companies Opt for Recapitalization

Several factors motivate a company to recapitalize. Companies may use recapitalization to defend against [hostile takeovers](https://www.investopedia.com/terms/h/hostiletakeover.asp). Management might issue more debt to deter potential acquirers.

Another reason is to reduce financial obligations. Higher debt levels compared with equity means higher interest payments. [Trading debt for equity](https://www.investopedia.com/ask/answers/06/debtequityswap.asp) reduces both debt levels and interest payments. This, in turn, improves the company’s overall financial well-being.

Recapitalization can also prevent share prices from dropping. If a company finds that its shares are declining in value, it may decide to swap equity for debt to push the stock price back up.

Some companies may also use recapitalization to minimize their tax payments, implement an [exit strategy](https://www.investopedia.com/terms/e/exitstrategy.asp) for venture capitalists, or reorganize themselves during a bankruptcy. Companies use it to diversify debt-to-equity ratios and enhance [liquidity](https://www.investopedia.com/terms/l/liquidity.asp).

## Exploring Different Types of Recapitalization

Companies can swap debt for equity or vice versa for many reasons. An example of equity replacing debt in the capital structure is when a company issues stock to buy back [debt securities](https://www.investopedia.com/terms/d/debtsecurity.asp), increasing its proportion of equity capital compared with its debt capital. This is called an equity recapitalization.

Debt investors require routine payments and a return of principal upon maturity, so a swap of debt for equity helps a company maintain its cash and use the cash generated from operations for business purposes, reinvestment, or capital returns to equity holders.

On the other hand, a company may issue debt and use the cash to buy back shares or issue [dividends](https://www.investopedia.com/terms/d/dividend.asp), effectively recapitalizing the company by increasing the proportion of debt in the capital structure. Another benefit of taking on more debt is that interest payments are tax deductible, while dividends are not. By paying interest on debt securities, a company can decrease its tax bill and increase the amount of capital returned in total to both debt and equity investors.

> **Important**
>
> Governments may buy back shares to get a controlling interest in a company important to a nation’s economy through nationalization—another form of recapitalization.

Governments also partake in the mass recapitalization of their countries’ banking sectors during times of financial crisis and when the solvency and liquidity of banks and the greater financial system come into question. For example, the U.S. government recapitalized the country’s banking sector with various forms of equity to keep the banks and the financial system solvent and maintain liquidity through the [Troubled Asset Relief Program (TARP)](https://www.investopedia.com/terms/t/troubled-asset-relief-program-tarp.asp) in 2008.

## How Does Recapitalization Work?

A company can use recapitalization to improve its financial stability or overhaul its financial structure. The company must change its debt-to-equity (D/E) ratio by adding more debt or more equity to its capital.

## Why Would a Company Consider Recapitalization?

Reasons include a drop in the business’s share price; to defend against a hostile takeover; to reduce financial obligations and minimize taxes; to provide venture capitalists with an exit strategy; or bankruptcy.

## What Forms Does Recapitalization Take?

Companies can swap debt for equity, or vice versa.

One version of equity replacing debt in the capital structure is equity recapitalization. This is when a company issues stock to buy back debt securities, increasing its proportion of equity capital compared with its debt capital.

One version of debt replacing equity in the capital structure is when a company issues debt and uses the cash to buy back shares or issue dividends. The business thus recapitalizes by increasing the proportion of debt in the capital structure.

## The Bottom Line

Recapitalization is a strategic tool to restructure a business’s debt and equity mixture. This may involve raising equity capital to pay off debts, or vice versa. Recapitalization can help a company fend off a hostile takeover, or manage struggling share prices. It can also help optimize their tax strategies.

However, companies that choose this route need to ensure that they retain sufficient liquidity to fund their operations during recapitalization.  

> **Article Sources**
>
> 1.  U.S. Department of the Treasury. “[Troubled Asset Relief Program (TARP): TARP Programs](https://www.treasury.gov/initiatives/financial-stability/TARP-Programs/Pages/default.aspx#).”