Paying dividend to Buyout firms?
Something that I don't understand. Can someone please clarify a bit. I often read articles saying that for example, company ABC is getting a term loan from a BB bank to pay dividend to a buyout firm that acquired company ABC a few years ago. If company ABC doesn't make good profit, why pay dividend? Since (i'm guessing) the buyout firm owns the majority of the company shares, why it's the company ABC itself getting a term loan from a BB bank and not the buyout firm?
It's called a dividend recapitalization. It allows the buyout firm to to generate a return on it's investment immediately while putting more debt on the company. The loan is secured by the company's assets. While this is a nice way to generate an immediate return if the company can support the debt load, problems do arise if the company becomes over leveraged because of the dividend recap and needs to default (this usually doesn't happen directly because of the recap, but in combination with other factors such as synergies failing to materialize or lower than expected sales growth). In which case the buyout firm has already secured a nice sum of money on its investment thanks to the dividend and lets their investment default
It's called a dividend recap.
The idea is this: XYX Capital buys ABC Co. for $100mm. The deal is financed with an $80mm term loan and $20mm in equity. 4 years later, the company has paid down its debt by 50% through its cash flows. ABC is still worth $100mm, but XYZ isn't ready to sell yet. Instead, they refinance the loan by taking out a new $80mm loan. With the $80mm of loan proceeds, they pay the remaining $40mm of debt and pay a $40mm dividend to the sponsor.
To answer your questions: 1) Usually in order to do a dividend recap the company either a) was purchased with relatively low leverage, b) has paid down a significant part of its debt, or c) has had significant growth/operating improvements and is now viewed as more valuable. A company that is struggling will usually have trouble getting a dividend recap. It happens, especially during the boom years, but it's a tough sell to lenders and the new loan is usually relatively pricey (in part because the market views a sponsor taking a dividend as "cashing out.")
2) The company is getting the term loan because the loan is backed by the assets of the company. PE firms are structured so that each investment is compartmentalized-XYZ wants to be protected if ABC goes bankrupt, and wants its other portfolio companies protected as well.
Got it. thanks a lot guys.
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