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What is a dividend recapitalization in simple terms?
What are the essential elements you should know!
In this article, I will break down the meaning of Dividend Recapitalization so you know all there is to know about it!
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Table of Contents
What Is A Dividend Recapitalization
A dividend recapitalization is when a company pays a special dividend to its shareholders by taking on debt.
In other words, unlike your traditional dividend that is paid out of company profits, when you’re looking at a dividend recapitalization, special dividends are paid out of new debt that the company has added to its balance sheet.
This means that a company is “borrowing” money to pay dividends to its shareholders.
Why Use Dividend Recapitalization
There are many reasons why a company would want to use debt to pay a special dividend to its shareholders.
The most common reason why a company will use the dividend recap model to pay special dividends is to allow private equity firms, private investors, venture capitalists, or other types of early investors to exit as an alternative route to an IPO.
Another reason why a recap of dividends will be considered is for private equity firms to remain invested in a private company but recover some of their initial investment to reduce risk.
Another reason why dividend recaps may be considered is to allow a company to reward its shareholders without using its earned profits and by tapping into a low-interest rate of interest on its debt.
Companies can also use the dividend recapitalization process to do minor capital restructuring or even major ones leading to changes in the power structure within a company.
Dividend Recapitalization Risk
Paying dividends using debt is certainly not something that companies can afford to do recklessly or without proper consideration.
Think about it, the company is using money it does not have to reward its shareholders.
Clearly, shareholders reap the reward but at the expense of the company having more debt on its balance sheet.
If the company does not carefully assess its cash flow needs, profitability, and has a good financial forecast, the additional leverage can increase the company’s risk of defaulting on its financial obligations.
When a company defaults on its debt payments, creditors will typically have the right to exercise various rights against the company to recoup their money.
In the worst-case scenarios, this can lead to a company being petitioned for bankruptcy.
Dividend Recap Private Equity Firms
You’ll see dividend recapitalizations when private equity firms or investment firms that have invested in a company want to take out some money without having to go through an IPO.
A private equity dividend recap allows a private equity firm to free up cash from its investment allowing it to reduce its risk exposure on its investment.
Private equity firms and private investors use the dividend recap method to recoup some of their money used to invest in a particular private company.
This is beneficial for them as they are able to reduce their investment risk and get back some of their capital to invest in other profitable ventures.
However, critics argue that this practice puts a significant debt burden on the private company which will need to live with the additional debt on its balance sheet.
By having more debt on its balance sheet, the company will appear riskier to banks and other traditional lenders and will be more vulnerable to changes in the market conditions.
Dividend Recapitalization Example
Let’s look at a dividend recapitalization private equity example to better understand how it works.
Imagine that a private equity firm invests $50,000,000 in a private company.
The private company is still not ready to get listed in the stock market via an IPO and so the private equity firm expects to remain invested for another 3 to 4 years.
To reward the initial round of investors that invested in this private company, the company takes on $10,000,000 in debt to pay a special dividend to shareholders.
The $10,000,000 dividend represents a 20% return on the private equity firm’s investment allowing them to reduce their investment exposure without diluting their share percentage in the company.
For the private company, it must deal with this additional debt on its balance sheet expecting that it will be able to assume this debt with its growing revenues.
Dividend Recap Takeaways
So, there you have it folks!
What does dividend recapitalization mean?
Dividend recapitalization, also known as dividend recap, refers to the process of having a private company take on new debt to pay special dividends to its shareholders.
Unlike regular dividends that are paid out of company profits (or the company’s net income), dividend recap money comes from new debt that the company has added to its balance sheet.
For a company to consider paying dividends using debt to fund the dividends, it must be very comfortable that its business can handle the additional debt burden.
Now that you know what dividend recapitalization means, why it is done, and how it works, good luck with your research!
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Understanding Dividend Recapitalization
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