What is Dividend Recapitalization?

A dividend recapitalization (also known as a dividend recap) happens when a company incurs a new debt in order to pay a special dividend to private investors or shareholders. This usually involves a company owned by a private investment firm, which can authorize a dividend recapitalization as an alternative to the company declaring regular dividends, based on earnings.

Understanding Dividend Recapitalization

The dividend recap has seen explosive growth, primarily as an avenue for private equity firms to recoup some or all of the money they used to purchase their stake in a business. The practice is generally not looked upon favorably by creditors or common shareholders as it reduces the credit quality of the company, while benefiting only a select few.

Prior to exiting a portfolio company, some private equity firms and activist investors opt to incur additional debt on the balance sheet of the company in order to deliver early payments to their limited partners and/or managers. This reduces risk for the PE firms and their shareholders.

This special dividend, in addition to not funding the portfolio company’s growth, weighs further on its balance sheet in the form of leverage. Significant new debt has the potential to become a drag in adverse market conditions, following the company’s exit.

Yet portfolio companies selected for dividend recapitalizations have historically been generally healthy and able to withstand additional debt. This is usually due to new developments, pushed for by private equity sponsors, which produce stronger cash flows. The healthy cash flows enable private equity sponsors to get immediate partial returns on their investment since other avenues of liquidity, such as public markets and mergers, take more time and effort.

Dividend recapitalizations reached a high during the 2006-2007 buyout boom.

Key Takeaways

  • Dividend recapitalization is when portfolio companies of a private equity firm take on additional debt in order to pay out dividends to investors.
  • The dividend reduces risk for PE firms by providing early and immediate returns to shareholders but increases debt on the portfolio company's balance sheet.

Example of a Dividend Recapitalization

In December 2017, Dover Corp. announced that it would spin off its oilfield services business, Wellsite. Wellsite would become a separate company, focused on specialized equipment – specifically, artificial lifts, which squeeze the final drops from oil wells after they’ve been fully drilled. As part of creation of this distinct entity, parent company Dover planned to issue a dividend recapitalization of ~$700 million, leaving Wellsite with long-term debt of 3.4 X EBITDA. While regular dividends go to preferred and common shareholders, in this example, the dividend is planned to fund a $1 billion buyback on Dover’s behalf, supported by activist investor Third Point, LLC.