Dividend Recapitalization

A dividend recapitalization (also known as a dividend recap) happens when a company incurs a new debt in order to pay a special dividend to private investors or shareholders. This usually involves a company owned by a private investment firm, which can authorize a dividend recapitalization as an alternative to the company declaring regular dividends, based on earnings.

The dividend recap has seen explosive growth, primarily as an avenue for private equity firms to recoup some or all of the money they used to purchase their stake in a business. The practice is generally not looked upon favorably by creditors or common shareholders as it reduces the credit quality of the company, while benefiting only a select few.

Prior to exiting a portfolio company, some private equity firms and activist investors opt to incur additional debt on the balance sheet of the company in order to deliver early payments to their limited partners and/or managers. This reduces risk for the PE firms and their shareholders.

This special dividend, in addition to not funding the portfolio company’s growth, weighs even further on its balance sheet in the form of leverage. Significant new debt has the potential to become a drag in adverse market conditions, following the company’s exit.

Yet portfolio companies selected for dividend recapitalizations have historically been generally healthy and able to withstand additional debt. This is usually due to new developments, pushed for by private equity sponsors, which produce stronger cash flows.

Dividend recapitalizations reached a high during the 2006-2007 buyout boom.

In December 2017, Dover Corp. announced that it would spin off its oilfield services business, Wellsite. Wellsite would become a separate company, focused on specialized equipment – specifically, artificial lifts, which squeeze the final drops from oil wells after they’ve been fully drilled. As part of creation of this distinct entity, parent company Dover planned to issue a dividend recapitalization of ~$700 million, leaving Wellsite with long-term debt of 3.4X EBITDA. While regular dividends go to preferred and common shareholders, in this example, the dividend is planned to fund a $1 billion buyback on Dover’s behalf, supported by activist investor Third Point, LLC.