Handbook of Finance: Investment Management and Financial Management

Chapter 63. Recapitalization of Troubled Companies

ENRIQUE R. ARZAC, PhD

Professor of Finance and Economics, Graduate School of Business, Columbia University

Abstract: Changes in economic conditions, overoptimistic projections, excessive debt, and managerial errors can precipitate default. How to deal with a company in financial distress depends on if it is worth more as a going concern than in liquidation. Salvaging the going concern requires a recapitalization of the company and the implementation of a turnaround plan directed to conserve cash, reduce expenses, stabilize cash flow, and assure economic viability. Liquidation involves an orderly selling of assets to maximize proceeds. The purpose of a recapitalization is to reduce the burden of debt on the cash flow of the company to make it consistent with its debt capacity and to maximize the cash recovery of the different claimants. Independently of the form of the original company, recapitalizing a distressed company is similar to structuring a leveraged buyout (LBO) in the sense that both use all the debt capacity that can be realistically managed and that the cash flows available to many of the claimants are in the distant future. However, negotiation under distress is more complicated in that creditors attempt to preserve their claims and can force unrealistic amortization schedules. A credible, realistic analysis of debt capacity and a fair valuation of the several instruments offered in exchange for the existing claims are ...