Why would a PE firm ever pay down debt when it could use FCF to pay a dividend? Wouldn't the time value of money almost always trump the interest payments you are saving by paying down debt?
I'm thinking if I have $100 of debt post interest, if I pay out a dividend, I get $100 today, but if I pay down debt I will gain a few dollars a year in interest and then $100 when I sell, so I would usually want $100 today right?
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I don’t have experience in the area so I could be wrong but in my view it depends on the interest rate on the debt. So if you have $ 100 in debt, then if your interest rate on the loan is more than you can earn in interest on the 100 dollars you’d get as a dividend you’ll have to pay in the next period then it’s be more useful to pay down the debt. so like if you had an interest rate of 10% and say you can reinvest at 9% you’d net -$1 since you get 9 in interest but have to pay 10 versus if you pay down the note next period you net 0. Of course this assumes that you can only earn less than the interest on the debt which isn’t always true so if you can then yeah I don’t see why you’d pay down the debt if you don’t have to. Again though I’m not experienced in this area but that’s just my thought process.
In order to finance the transaction often times the subordinated debt holders / other stakeholders will require covenants that prohibit sponsors from sucking cash out of the business which would mean they are not able to issue dividends
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