Dividend recapitalisation
LBORaising new debt in a portfolio company and paying the proceeds to its shareholders, without any change of ownership.
Also written: dividend recap, divi recap, leveraged recapitalisation
A dividend recapitalisation is a financing event dressed as a distribution. The company borrows more and passes the money to its shareholders. Nobody buys the business, nobody sells it, and the operating plan is untouched. The sponsor takes cash out of an asset it still owns and still has to exit.
The cash comes from lenders rather than from profits. Debt rises, the proceeds pass straight out, and book equity falls by the amount distributed, which can turn negative in a company that is trading normally. Enterprise value does not move. What moves is the split between debt and equity, and therefore how much of the risk the sponsor is carrying and how much the lenders are.
Sponsors do it for four reasons worth separating. It converts a paper return into a realised one, and distributions are money where carrying values are opinions. It is the only liquidity available when exit markets are shut, and buys time to sell into a better one. It re levers a business that deleveraged faster than plan. And it takes the downside case off the table once the amount taken out approaches the original cheque.
It creates no value, and saying so is the answer that separates a good candidate from a fluent one. It improves the timing of a return and worsens its size slightly, because the company pays interest on money the sponsor has already removed, and it consumes covenant headroom, which is the part that bites if the business then has a bad year.
Worked example
An illustrative deal: 280 of equity in, 730 out after five years, a MOIC of 2.61 times and an IRR of about 21%.
Take 150 out at the end of year three. The plan is unchanged so exit enterprise value is unchanged, but net debt at exit is about 166 higher once the extra after tax interest is counted, so exit equity falls to roughly 564.
Total cash back is 714 rather than 730, so MOIC falls to 2.55 times, while the IRR rises to about 23% because 150 arrived two years early. Timing improved, size did not, and covenant headroom fell from an EBITDA decline of about 38% to about 11%.