What is a Dividend Recapitalization?
A Dividend Recapitalization is a strategy used by private equity firms to increase their fund returns from a leveraged buyout (LBO).
In a dividend recapitalization transaction, often abbreviated as “dividend recap”, the post-LBO portfolio company of a financial sponsor raises more debt capital to issue its equity shareholders (i.e. the private equity firm) a special, one-time cash dividend.
Dividend Recapitalization: LBO Partial Exit Strategy
When a private equity firm completes a dividend recapitalization, additional debt financing is raised with the specific intent to issue a special, one-time dividend using the cash proceeds from the newly-raised debt.
While there are exceptions, dividend recaps are completed once the post-LBO portfolio company has paid down a substantial portion of the initial debt used to fund the initial LBO transaction.
Since the default risk is reduced and there is now more debt capacity — meaning that the company could reasonably handle more debt on its balance sheet — the firm can opt to complete a dividend recap without breaching any existing debt covenants.
The availability of sufficient debt capacity is necessary for the dividend recap to even be an option. However, the state of the credit markets (i.e. interest rate environment) is also an important factor that can determine the ease (or difficulty) of achieving a recap.
The rationale for completing a dividend recap is for the financial sponsor to partially monetize an investment without needing to undergo an outright sale, such as an exit to a strategic acquirer or another private equity firm (i.e. secondary buyout), or an exit via an initial public offering (IPO).
A dividend recap is therefore an alternative option where there is a partial monetization for the sponsor from the recapitalization of their investment and receipt of a cash dividend funded by the newly borrowed debt.
