What Does Debt Recapitalization Mean?
A debt recapitalization is a strategy that allows owners to take cash out of the business and transfer the risk of investment into other asset classes. In this process, an outside financing source provides debt capital in the form of senior and/or mezzanine debt to facilitate a distribution of cash to the business owners.
Divestopedia Explains Debt Recapitalization
In a debt recapitalization, an owner simply goes to the bank and asks for a loan in the company. Based on the net tangible assets, future cash flows and ability to meet future financial covenants, the bank would provide a certain amount of debt that could be distributed to the owner through various mechanisms, such as a dividend. The amount of debt provided (in the form of either senior or mezzanine financing) would depend on the qualitative and quantitative characteristics of the business.
- A business owner will retain 100 percent ownership of the company.
- The process is relatively quick — typically three to four months — because owners need only negotiate with the bank.
- This type of financing can be done confidentially, with minimal disruption to the operations of the business.
- Personal guarantees will very likely be required by the bank as secondary security for the additional debt obtained. So, even though the business owner has taken cash out of the business, risk still remains with the personal guarantees. Owners need to assess whether they can stomach this extra debt.
- There will be increased reporting required by mezzanine and senior debt providers.
- Additional debt on a business will increase the stress cash flow, since lenders will require sufficient cash to cover the debt servicing requirements. This can affect a company’s ability to grow.