Leveraged recapitalizations are used by privately held companies as a means of refinancing, generally to provide returns to the shareholders while not requiring a total sale of the company. These types of recapitalizations can be minor adjustments to the capital structure or may involve a change of control. Carrying debt comes with a lot of advantages in the form of tax benefits and cash discipline as compared to equity. However, this often leads companies to focus on short-term cash flow projects, and they tend to lose their strategic focus. As shown in the research article: Leverage and Internal Capital Markets , the leveraged companies had increased their debt to capital ratio from 17% to 50% in a span of 12 years.
Leveraged recapitalizations are also used as a strategy to fend off a hostile takeover. Under this strategy, a company incurs significant additional debt to repurchase stocks through a buyback program or distributes a large dividend among the current shareholders. This will cause the share price to increase significantly, making the company a less attractive takeover target. Following a leveraged recapitalization, a raider would pay more, thus minimizing any gains and acting as a deterrent.
The strategy, a popular form of poison pill, serves two purposes: 1) increase debt to make the acquisition price more costly, and 2) to maintain shareholder interest in takeover attempts.