Question on the "Dividend Recap"

Would it be possible for a private equity sponsor to issue themselves a dividend with the a portfolio company's excess cash flow, rather than by taking on new debt (assuming they have paid their mandatory amortization on the existing debt)?

TLDR; Can a a sponsor do the "dividend" without the "recap"?

 

I figured there would be sort of covenant / restriction, but don't those covenants also cover taking on new debt to pay a dividend? Taking out debt to fund a dividend seems like it would be more risky to a creditor than taking out cash to fund a dividend. In one instance, only cash is gone, while in the other, cash is gone and new debt is added.

Why do creditors see dividend recaps as less risky than cash dividends?

 

Haven't worked too much on dividend recaps, but re-instating debt is typically good for the debtholder. If cash leaves the firm, that's firm value leaving the firm for the benefit of shareholders, NOT debtholders. Reinstating debt gives them a promise that there will be future interest and principal for the debtholder.

 

Oh I see, so it's a way of aligning the debt and equity holders of the business?

 

Sorry, stepping in. This isn't correct.

Credit agreements have restrictions on all sorts of activities - taking on additional indebtedness, paying out dividends, using cash to make acquisitions, etc. Many of these are governed by net leverage ratios.

Most LBO debt holders do not like companies to over lever - that's why not all LBOs are done at 6.5x leverage! There are certainly lenders that are looking to put more capital to work and may be willing to lend companies more money to finance acquisitions, dividends etc., but more debt = better for lenders is wrong.

Not sure how you are concluding that div-recaps are less risky than cash dividends. The borrower will be restricted by 2 buckets under a credit agreement if doing a div recap - ability to take on additional debt, ability to make a restricted payment. Borrower will be restricted just by the restricted payment bucket on the cash-payout scenario. In both cases leverage has to be low enough to permit the dividend.

 
Most Helpful

Having debt on the business will always be riskier than no debt, all else equal. A dividend recap by definition boosts the amount of cash you can otherwise take out from the business, all else equal, by definition. To simplify, imagine two scenarios for a sponsor-owned company with no debt, generating $10M of EBITDA annually, that has accumulated $10M of cash on its balance sheet, and lenders in the market are comfortable with a 5x net leverage profile:

(A) At $10M of net cash today, you can immediately raise $60M of debt as part of a dividend recap. After, your net debt is $50M, and you begin paying down the balance over time. The "excess cashflow" annually you otherwise would lose to interest expense from the debt is justified by the ability to take out a chunk of your money (or >100% of your invested capital) in one lump sum, today

(B) You choose to pay out your $10M of cash today, and annually thereafter, you take out excess cash generated, taking out your money over time (with no interest expense / no debt)

This is a big simplification and it's not so extreme in practice, but directionally that's how a recap juices a sponsor's time-weighted return.

 

I did not insinuate that more debt is necessarily good. Of course lenders do not want the company to over lever. But your points do not really answer the question as to why lenders are willing to accept dividend recaps when value is leaving the firm.

 

Dividend recaps are rarely done as incremental deals for this very reason. Usually the tx is a completely new facility with a completely new document done on a company that has had broadly syndicated debt and has performed well.

 

Quisquam delectus nihil saepe libero. Et voluptate eum aut incidunt id eligendi dolor. Est qui facilis ducimus est. Assumenda et ut minima eum qui earum.

Sed repellendus rerum distinctio occaecati labore blanditiis. Esse qui neque ut id. Laboriosam libero in aut sit et accusamus blanditiis. Cum enim error incidunt libero. Reiciendis aut aperiam dolor doloremque est quasi dolor.

Laborum quis recusandae tempora id tenetur id. Corporis enim dignissimos commodi nesciunt. Eum eum deleniti praesentium voluptatem aut sed itaque. Ipsam doloribus dolores corporis velit dolorem.

Similique sint et optio iure. Aut tempore sed ut cupiditate quis velit in. Fugit aut repellat ipsum dolores sunt sed debitis.

Career Advancement Opportunities

March 2024 Private Equity

  • The Riverside Company 99.5%
  • Warburg Pincus 99.0%
  • Blackstone Group 98.4%
  • KKR (Kohlberg Kravis Roberts) 97.9%
  • Bain Capital 97.4%

Overall Employee Satisfaction

March 2024 Private Equity

  • The Riverside Company 99.5%
  • Blackstone Group 98.9%
  • KKR (Kohlberg Kravis Roberts) 98.4%
  • Ardian 97.9%
  • Bain Capital 97.4%

Professional Growth Opportunities

March 2024 Private Equity

  • The Riverside Company 99.5%
  • Bain Capital 99.0%
  • Blackstone Group 98.4%
  • Warburg Pincus 97.9%
  • Starwood Capital Group 97.4%

Total Avg Compensation

March 2024 Private Equity

  • Principal (9) $653
  • Director/MD (21) $586
  • Vice President (92) $362
  • 3rd+ Year Associate (89) $280
  • 2nd Year Associate (204) $268
  • 1st Year Associate (386) $229
  • 3rd+ Year Analyst (28) $157
  • 2nd Year Analyst (83) $134
  • 1st Year Analyst (246) $122
  • Intern/Summer Associate (32) $82
  • Intern/Summer Analyst (313) $59
notes
16 IB Interviews Notes

“... there’s no excuse to not take advantage of the resources out there available to you. Best value for your $ are the...”

Leaderboard

1
redever's picture
redever
99.2
2
Secyh62's picture
Secyh62
99.0
3
Betsy Massar's picture
Betsy Massar
99.0
4
BankonBanking's picture
BankonBanking
99.0
5
kanon's picture
kanon
98.9
6
DrApeman's picture
DrApeman
98.9
7
dosk17's picture
dosk17
98.9
8
CompBanker's picture
CompBanker
98.9
9
GameTheory's picture
GameTheory
98.9
10
numi's picture
numi
98.8
success
From 10 rejections to 1 dream investment banking internship

“... I believe it was the single biggest reason why I ended up with an offer...”