Dividend Recapitalization

The portfolio company raises new debt (term loan or bond), and the proceeds are paid out as a special dividend to shareholders — primarily the PE sponsor. For example, a company with $300M EBITDA at 4.0x leverage raises $200M in new debt (pushing leverage to 4.7x) and pays it as a dividend. The sponsor recovers a portion of their initial equity investment while retaining ownership.

Dividend recaps dramatically improve IRR because the sponsor receives cash earlier. If a sponsor invested $500M equity and receives a $200M dividend in Year 2, the remaining equity at risk is $300M. Even if the exit value is the same, the IRR is higher because $200M came back 3 years earlier. However, the money-on-invested-capital (MOIC) improvement is more modest because the total cash received only increases by the dividend amount.

Dividend recaps increase the company's debt burden and interest expense, which can be risky if earnings decline. Critics argue they prioritize sponsor returns over company health. Lenders scrutinize dividend recap requests carefully and may restrict them through 'restricted payments' covenants in credit agreements. Despite the controversy, recaps are a common and legal PE tool.