Define: Capital Restructuring

Capital restructuring involves the process of reorganising a company’s capital structure, which includes its debt and equity. This restructuring may involve various actions such as issuing new shares, repurchasing existing shares, issuing debt securities, or converting debt into equity. The purpose of capital restructuring is to improve the financial position and performance of the company, enhance shareholder value, and address any financial distress or inefficiencies. It is important for companies to comply with applicable laws, regulations, and corporate governance requirements when undertaking capital restructuring activities.

A company undertakes restructuring when it significantly modifies its financial and operational aspects, typically in response to financial duress or industry pressures, aimed at limiting financial harm and improving business performance. However, aside from negative triggers, restructuring can also be driven by other factors such as preparing for a sale, buyout, merger, change in direction, growth, or transfer of ownership.

Fundamentally, businesses require capital to operate effectively, which is sourced from revenue and capital injections through debt and equity. The combination of debt and equity forms the capital structure of a business. Capital restructuring refers to the process of altering this mix of debt and equity. It involves changing the capital structure to optimise profitability, facilitate growth, or respond to crises like bankruptcy or changing market conditions. This approach is primarily used to address changes that affect a company’s financial stability.

Factors influencing the choice of capital structure:

• Risk Appetite: Each company has a unique risk profile influenced by industry, maturity, scale, management expertise, customer base, product mix, and diversity. The company’s risk tolerance determines the proportion of debt and equity it adopts, considering the cost of capital and ownership reduction.
• Short-term and Long-term Goals: Debt or equity plays a critical role in funding a company’s objectives and aspirations. The time horizon for achieving these goals significantly impacts the financing decision. For instance, equity may not be suitable for short-term goals due to ownership dilution and loss of control.
• Financial Health: Factors like revenue, cash flow, cash reserves, and existing debt affect the choice between debt and equity, as they determine the ability to meet financial obligations.
• Owner’s Profile: Characteristics such as age, marital status, estate planning, succession intentions, legal considerations, and exit strategies influence the funding strategy. The future direction of the company, especially for family businesses, can differ based on these factors. For instance, older business owners might prioritise succession planning, while newer founders may focus on growth without significant equity dilution or long-term debts.
• Tax Considerations: The choice between debt and equity financing has tax implications that should be carefully evaluated. Tax regulations also dictate capitalization rules that companies must adhere to, making tax planning a crucial factor in capital structure decisions.

Types Of Capital Restructuring

Capital restructuring involves two primary forms: debt restructuring and equity restructuring.

Debt Restructuring:

Debt restructuring encompasses the reorganisation of a company’s entire debt capital. It is typically employed to mitigate the risk of default on existing debts and provide a more cost-effective alternative to bankruptcy. Companies aim to minimise the cost of capital and enhance operational efficiency, necessitating continuous debt review.

Debt restructuring can be executed through various methods, including:

• Utilising market opportunities to replace high-cost debt with lower-cost borrowings.
• Reducing borrowing costs and enhancing the working capital position.
• Implementing a debt-for-equity swap, where creditors agree to cancel a portion or all of the outstanding debt in exchange for equity in the company.
• Entering into formal agreements involving renegotiation of interest rates or extension of loan terms.
• Implementing a ‘haircut,’ where a portion of outstanding interest payments is forgiven or a portion of the principal is not repaid,.
• Issuing callable bonds to protect against potential interest payment defaults. Callable bonds allow for early redemption by the issuer during periods of declining interest rates and provide flexibility for future debt restructuring by replacing existing debt with new debt at lower interest rates.

Equity Restructuring:

Equity restructuring involves the reorganisation of a company’s equity capital, including reshuffling shareholders’ capital and reserves on the balance sheet. Given that equity restructuring pertains to the ownership of companies, it is a legal process subject to high regulation. Equity restructuring typically focuses on capital reduction.

Various methods of equity restructuring include:

• Share Repurchase: This involves reducing the company’s liability to shareholders by repurchasing shares, resulting in a capital reduction through the return of share capital.
• Change of Share Nature: This allows for the transformation of equity capital into redeemable preference shares or loans.
• Writing Down Share Capital: This reduces the company’s debt owed to shareholders without physically returning equity capital in cash.
• Consolidation or Subdivision of Shares: Consolidation involves combining existing shares into fewer, larger-value shares, whereas subdivision entails dividing existing shares into a greater number of smaller-value shares. These actions can adjust the overall structure of the company’s equity capital.

Reasons for Equity Restructuring:

Equity restructuring is undertaken for several reasons, including:

• Correction of Overcapitalization: Adjusting the company’s capital structure to align with its actual operational needs and financial position, avoiding excessive equity relative to operational requirements.
• Reorganising Capital for Improved Efficiency: Optimising the Allocation and Utilisation of Equity Capital to Enhance Operational Efficiency and Profitability.
• Writing Off Unrecognised Expenditure: Addressing or writing off unrecognised expenses or losses from the company’s financial records through equity restructuring.
• Maintaining a Favourable Debt-Equity Ratio: Balancing the mix of debt and equity to maintain an optimal debt-equity ratio that supports financial stability and creditworthiness.
• Asset Revaluation: Revaluing company assets to reflect current market values, which can impact the equity structure and valuation.
• Raising Fresh Finance: Using equity restructuring as a strategy to facilitate the raising of new funds or investment capital for business expansion or operational needs.

Capital restructuring is a recurring process that businesses must undergo throughout their lifecycle. Regularly reviewing your capital structure is essential to maintaining a healthy and thriving business. It’s crucial to keep these considerations in mind as you manage and plan for growth. Moreover, anticipating market downturns and economic recessions will keep you vigilant in ensuring that your funding structure on the balance sheet aligns with the prevailing economic conditions.

This site contains general legal information but does not constitute professional legal advice for your particular situation. Persuing this glossary does not create an attorney-client or legal adviser relationship. If you have specific questions, please consult a qualified attorney licensed in your jurisdiction.

This glossary post was last updated: 29th April 2024.