Debt may strangle the financial life of a business. By restructuring their debt, some businesses have been able to get access to the cash flow needed to make decisions that lead to future growth. The corporate restructuring process a business goes through, with the goal of changing its capital structure is referred to as recapitalization. Businesses usually perform recapitalization to optimize or stabilize their capital structure. At its core, recapitalization is a form of corporate restructuring where a business exchanges one type of financing for another type of financing. For example, a business might exchange equity for debt or debt for equity. Corporations may issue debt with the goal of purchasing assets or buying back equity shares.
What Is Private Equity Recapitalization?
Private equity recapitalization is a form of recapitalization that can be used by businesses interested in raising capital. Some business owners who are looking at starting a new venture may consider selling their business as a way of raising capital. Unfortunately, the opportunity to sell their business may arise when the economy is either doing poorly or at a point where economic growth seems to be on the horizon. Private equity recapitalization offers an alternative. It should allow a business owner to sell off a portion of their business to a private equity firm. This usually aids the business owner in raising capital and allows them to enjoy the future growth of their business or an upswing in the economy. Besides helping with raising capital, private equity firms may be valuable business partners. They might bring operational and organizational expertise to a firm, which may increase a firm’s assets.
Using Recapitalization for Debt Restructuring
In addition to raising capital, a corporation with a negative debt mixture may use recapitalization to improve its debt-to-equity ratio, minimize taxation, improve liquidity, and otherwise improve the structure of its business for strategic purposes. Recapitalization might help a corporation create a debt mixture that has a balance of debt and equity that will allow it to pay off its debts and provide a reasonable profit for owners. Leveraged recapitalization should help a company to take some of its equity and replace the equity with the debt, thereby adjusting its capital structure. For example, a company may issue bonds to help in raising capital. Leveraged recapitalization is traditionally used if a firm’s share price declines. For example, a company might issue debt securities, thereby raising capital that can purchase back its outstanding shares in the market. When the number of outstanding shares is reduced, a company may increase the price of its shares. Conversely, with an equity recapitalization, a company might issue new equity shares with the goal of raising capital that can purchase back debt securities. This move can have positive results for companies that have a negative debt-to-equity ratio. When a company has more debt than equity, it usually carries a lot of burdens. It may have to pay high interest on its debt securities. Having a high debt level may decrease a company’s value in the eyes of investors.
Accounting and Tax Implications
Raising capital for your business is a complex issue and might present challenges when accounting for recapitalization and reporting such transactions to the IRS. You would need to hold your wits to adequately process these types of transactions as specific accounting rules may need to be considered. These rules are also changed and updated – for example in May 2021, the FASB released updated accounting standards that can affect businesses if it is a free-standing written call option classified in equity. These accounting standards might affect the way you account for recapitalization within your business. If you are considering bankruptcy or there are attempts for a takeover of your business, it can relieve debt burdens and help with regaining financial stability, but the holistic picture will have to be assessed by an accountant. Having your corporate structure evaluated by a CPA is a significant factor that helps determine if it is the right time for capitalization restructuring. With bookkeeping and tax planning services for recording recapitalization accounting entries and other financial transactions, you can rebuild a powerful company for future growth. Contributing to a transaction complexity is when a corporation uses recapitalization to exchange between its shareholders or security holders.
Part of the CFO business advisory services we offer here at Fusion CPA includes helping our clients evaluate their current corporate structure and determining if the time is right for restructuring via recapitalization. The accountants at Fusion CPA are dedicated to helping you create strategies designed to reduce financial burden, prevent a hostile takeover, or reorganize during a bankruptcy. Our financial advisers are here to help you take a proactive approach to your tax planning and bookkeeping, helping you build a powerful company now and grow your business in the future. Learn more about the services our teams of accountants provide by clicking the button below and scheduling a discovery call today.
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