Dividend Recapitalization
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Dividend Recapitalization - form of financial leverage, which provides a PE investor to extract capital from a company and decrease its capital at risk without affecting the company's ownership structure. Recapitalizations are typically funded either from cash on hand in the portfolio company (non-leveraged dividend recapitalizations) or by releveraging the balance sheet through assigning new debt securities (leveraged dividend recapitalizations) [1].
The meaning of Recapitalization
Recapitalization - also known as recap or refinancing, in its simplest form, involves a company borrowing money and managing the proceeds to purchase some of the owner's equity ownership or to pay distinctive dividends [2].
Leveraged Recapitalization
A leveraged recapitalization involves releveling the portfolio company, based, for instance, on the company's earnings. The remaining portion of the ownership that exceeds the total firm assessment at that time flows back to the private equity fund that owns the company. In such a transaction the private equity fund pulls out the equity invested without selling the company. Since special dividends generate tax consequences, private equity investors may prefer to share repurchases. However, some companies use a combination of the two, repurchasing some shares and distributing the remainder of the recap as a special dividend [3].
Non-leveraged recapitalizations
Non-leveraged recapitalizations could be funded through excess operating cash flow or the divestment of a business line and are typically more inadequate than those funded through new debt issuance [4].
Advantage of Dividend Recapitalization
A dividend recapitalization could possess several advantages in maximizing returns. The most well-known advantage is to lengthen the holding period of the company while still raising cash to expend for the fund's needs. If the market environment is not the most beneficial for the target company exit, a dividend recapitalization would allow the fund more time to look for the right exit opportunity [5].
Examples of Dividend Recapitalization
- A dividend recapitalization can take place in the form of a dividend payment from the company to its shareholders. This is typically done by taking on additional debt, which the company then uses to pay out the dividend. For example, a private equity firm may acquire a company, restructure its debt, and then issue a dividend payment to the shareholders. This can be used to both reward shareholders and reduce the amount of equity capital at risk in the company.
- Another form of dividend recapitalization is a stock repurchase, which is when the company buys back its own shares from the shareholders. This can also be used to reward shareholders and reduce the amount of equity capital at risk in the company. For example, a company may decide to repurchase its own stock when its share price is low in order to reward shareholders, reduce the amount of equity capital at risk, and increase the value of the remaining shares.
- A third example of dividend recapitalization is a special dividend, which is a one-time dividend payment made to shareholders. This is typically done by taking on additional debt or issuing new shares of stock. This can be used to reward shareholders and reduce the amount of equity capital at risk in the company. For example, a company may issue a special dividend in order to reward shareholders who have been loyal to the company over a long period of time.
Limitations of Dividend Recapitalization
Dividend recapitalization is a form of financial leverage, which provides a PE investor to extract capital from a company and decrease its capital at risk without affecting the companys ownership structure. However, there are several limitations to consider when evaluating this strategy, including:
- Increased debt: Dividend recapitalization increases the amount of debt on the balance sheet, which might increase the risk of default and harm the company's credit rating.
- Unfavorable tax consequences: Dividend recapitalization can lead to unfavorable tax consequences, such as higher taxes on dividends received by shareholders.
- Negative impact on share price: Dividend recapitalization can have a negative impact on the share price, as it can signal to the market that the company is struggling financially.
- Potentially limited access to capital: Dividend recapitalization can limit access to capital, as the company is reducing its capital base and depriving itself of potential growth opportunities.
- Risk of overleveraging: If the company overleverages itself through dividend recapitalization, it can become too heavily leveraged and unable to service its debt obligations.
Dividend recapitalization is a form of financial leverage that enables a private equity investor to extract capital from a company and reduce its capital at risk without affecting the company's ownership structure. Other approaches related to dividend recapitalization include:
- Debt Refinancing: Refinancing existing debt with a new loan, often at lower interest rates, to reduce overall debt burden and increase cash flow.
- Leveraged Buyouts (LBO): Purchasing a company with a combination of debt and equity financing, where the majority of the purchase price is borrowed and paid back using the company’s future cash flows.
- Equity Infusions: Injecting additional equity capital into a company to increase its financial flexibility and strength.
- Asset-Based Financing: Securing a loan against the company's assets, such as real estate, equipment, and inventory.
In summary, dividend recapitalization is a form of financial leverage used to extract capital from a company and reduce its capital at risk without affecting the company’s ownership structure. Other approaches related to dividend recapitalization include debt refinancing, leveraged buyouts, equity infusions, and asset-based financing.
References
- Pignataro P. (2017), The Technical Interview Guide to Investment Banking John Wiley & Sons
- Stefanova M. (2015), Private Equity Accounting, Investor Reporting, and Beyond: Advanced Guide for Private Equity Managers, Institutional Investors, Investment Professionals, and Students FT Press
- Talmor E., Vasvari F. (2011), International Private Equity John Wiley & Sons
- Zeisberger C., Prahl M., White b. (2017), Mastering Private Equity: Transformation via Venture Capital, Minority Investments and Buyouts John Wiley & Sons
Footnotes
Author: Klaudia Wojtas
