The Resurgence of Dividend Recap Transactions in 2024

Introduction

As a company owner navigating the complex landscape of corporate finance in 2024, you’re likely seeking innovative ways to optimize your business’s capital structure and unlock value. In recent years, one financial strategy has gained significant traction: the dividend recapitalization, commonly known as a “dividend recap.” This resurgence presents both exciting opportunities and potential challenges for businesses of all sizes.

Note: This comprehensive analysis delves deep into the world of dividend recaps from the perspective of company owners. Our goal is to equip you with the knowledge to make informed decisions about whether a dividend recap could benefit your business.

The increasing popularity of dividend recaps across various industries suggests a shift in how businesses approach capital management and shareholder value creation. As we explore this trend, we’ll examine the driving factors, potential benefits, and associated risks, providing you with a roadmap to navigate this complex financial terrain.

Understanding Dividend Recapitalizations

What is a Dividend Recapitalization?

A dividend recapitalization is a financial maneuver where a company takes on new debt to pay a special dividend to its shareholders. This transaction effectively replaces equity with debt on the company’s balance sheet, altering its capital structure.

Example: Imagine your company has $100 million in equity and no debt. Through a dividend recap, you might borrow $50 million and immediately pay that out as a dividend to shareholders. Post-transaction, your company would have $50 million in equity and $50 million in debt.

This strategy can be particularly appealing in a low-interest-rate environment, where the cost of debt is relatively low compared to the cost of equity.

Historical Context

Dividend recaps aren’t a new phenomenon. They gained popularity in the early 2000s, particularly among private equity-owned companies. However, their use declined sharply during the 2008 financial crisis as credit markets tightened and regulators scrutinized leveraged transactions more closely.

The technique’s resurgence in recent years marks a significant shift in financial strategies, reflecting changes in the economic landscape and corporate priorities.

Why Consider a Dividend Recap?

As a business owner, you might consider a dividend recap for several compelling reasons:

Unlock Value: Extract cash from your business without selling equity or losing control. This can be particularly attractive if you’ve built significant value in your company but haven’t had a liquidity event.
Optimize Capital Structure: Potentially reduce your overall cost of capital by introducing debt. In many cases, debt can be less expensive than equity, especially in a low-interest-rate environment.
Fund Growth or Acquisitions: Use the dividend to reinvest in other business opportunities. This could include expanding your current operations, entering new markets, or acquiring complementary businesses.
Provide Liquidity to Shareholders: This is especially relevant if you have minority shareholders or are considering a partial exit strategy. It allows for a cash distribution without a full sale of the company.
Tax Efficiency: In some jurisdictions, dividends may be taxed at a lower rate than capital gains, making a recap a tax-efficient way to extract value from your business.
Maintain Control: Unlike selling equity, a dividend recap allows you to maintain your current ownership percentage and control of the company.
Prepare for Future Transactions: A dividend recap can be a stepping stone to other strategic moves, such as a future sale or IPO, by demonstrating your company’s ability to handle leverage.

Current Trends in Dividend Recaps

Our analysis of recent transactions reveals several key trends that company owners should be aware of:

Diverse Industries: Dividend recaps are occurring across a wide range of industries, from manufacturing and technology to healthcare and energy. This diversity suggests that the strategy’s applicability is not limited to any particular sector.
Various Company Sizes: While often associated with large corporations, we’re seeing dividend recaps in companies of all sizes, including small and medium-sized enterprises. This democratization of the strategy opens up possibilities for a broader range of business owners.
Multiple Financial Partners: Many transactions involve multiple lenders or financial institutions, suggesting a robust market for these deals. This competition can lead to more favorable terms for borrowers.
Significant Transaction Sizes: The dividend recaps we’ve analyzed range from $5 million to over $1 billion, with a median around $50-75 million. This wide range indicates that the strategy is scalable to different company sizes and capital needs.
Increasing Frequency: Our data suggests a year-over-year increase in the number of dividend recap transactions, indicating growing acceptance and understanding of this financial strategy.

Industry Examples

Let’s examine some recent dividend recap transactions across various sectors:

Manufacturing Sector

8020.net: This developer and manufacturer of modular aluminum T-slot building systems completed a $50 million dividend recap in February 2024. This transaction demonstrates the appetite for these deals in the industrial sector, even for specialized manufacturers.
Waupaca Foundry: A supplier of cast and machined iron castings announced a $50 million dividend recap for July 2024. This shows continued interest in the manufacturing space, particularly for companies with strong market positions.

Technology and Software

Greenhouse.com: This recruiting platform executed a $26.88 million dividend recap in September 2022, highlighting the trend in the tech sector. It’s worth noting that this transaction involved multiple financial partners, including AB Private Credit Investors and The Carlyle Group.
Cyara.com: This automated CX assurance platform raised $79 million in June 2023, partly for dividend recap purposes. This transaction showcases how high-growth tech companies are leveraging dividend recaps to provide returns to early investors while maintaining growth trajectories.

Healthcare and Services

GHR Healthcare: This healthcare staffing services provider completed a $40.5 million dividend recap in September 2022. This transaction indicates the strategy’s relevance in service-oriented businesses, particularly in high-demand sectors like healthcare.
Viking Cloud: A provider of cybersecurity and compliance services executed a $92.5 million dividend recap in February 2024. This substantial transaction demonstrates the significant sizes possible in the services sector, particularly for companies in high-growth areas like cybersecurity.

Energy and Infrastructure

Generation Bridge: This operator of electric power generation facilities completed a $45 million dividend recap in October 2022. This transaction shows how even capital-intensive industries are utilizing dividend recaps.
Hess Midstream: This midstream energy company executed a $100 million dividend recap in July 2023. This large transaction indicates the continued use of this strategy in the energy infrastructure space, even for publicly traded entities.

These examples illustrate that dividend recaps are a versatile tool being employed across various industries and company sizes. As a business owner, it’s crucial to understand how this trend might apply to your specific situation and industry.

Factors Driving the Surge in Dividend Recaps

Several economic and market factors have contributed to the increased prevalence of dividend recaps. Understanding these drivers can help you assess whether the timing might be right for your company.

1. Low-Interest Rate Environment

Despite recent increases, interest rates remain relatively low by historical standards. As of June 2024, the yield on the 10-year U.S. Treasury bond hovers around 2.3%. This environment has two primary effects on dividend recaps:

Reduced Borrowing Costs: Your company can potentially secure debt at lower interest rates, making leveraged transactions like dividend recaps more attractive. This can significantly reduce the cost of capital for your business.
Yield-Seeking Behavior: Lenders, faced with low returns on traditional investments, may be more willing to finance dividend recaps in search of better yields. This increased appetite from lenders can lead to more favorable terms for borrowers.

Example: EOS Fitness, a chain of fitness clubs, was able to complete a $12.5 million dividend recap in April 2024, leveraging the low-interest environment to optimize its capital structure.

2. Increased Access to Leveraged Loans

The lending landscape has evolved significantly in recent years. Banks are no longer the sole gatekeepers of corporate credit, with private debt funds and a growing leveraged loan market expanding access to credit for many companies.

Our data shows that companies like Antares Capital, Churchill Asset Management, and Golub Capital are frequently involved in dividend recap transactions across various industries. This diversification of funding sources has several implications for business owners:

More Options: You’re not limited to traditional bank loans. Alternative lenders may offer more flexible terms or be willing to work with companies that don’t fit conventional banking criteria.
Competitive Terms: With more players in the market, you may be able to negotiate more favorable terms for your dividend recap.
Industry Expertise: Many of these lenders specialize in certain industries, potentially offering valuable insights and tailored solutions.

For instance, the dividend recap of Clarity SSI, a developer of cloud-based member communication software, involved Churchill Asset Management providing both a term loan and a revolving credit facility, showcasing the flexibility these lenders can offer.

3. Economic Recovery and Growth Opportunities

As the global economy continues to recover and grow, many business owners are looking to optimize their capital structures to support long-term growth and shareholder returns. Dividend recaps offer a way to:

Reward yourself and other shareholders without selling equity
Take advantage of favorable borrowing conditions
Free up capital for reinvestment or expansion

This is particularly evident in sectors that have seen strong growth or recovery. For example, Archkey Solutions, an electrical and technology construction firm, completed a $75 million dividend recap in November 2023, likely capitalizing on the construction industry’s robust recovery.

4. Private Equity Influence

While not all dividend recaps involve private equity firms, their strategies have influenced the broader market. If your company has private equity investors, they may be particularly interested in dividend recaps as a way to realize partial returns on their investments without exiting completely.

This trend is evident in transactions like the $80 million dividend recap of MetaMetrics, a provider of scientific measures for academic achievements, which involved private equity-focused lenders AB Private Credit Investors and Antares Capital.

Considerations for Company Owners

If you’re contemplating a dividend recap for your business, here are key factors to consider:

1. Financial Health and Stability

Before pursuing a dividend recap, it’s crucial to assess your company’s financial health:

Cash Flow: Can your business comfortably service the new debt? Analyze your historical and projected cash flows to ensure you have a sufficient cushion.
Growth Prospects: Are there opportunities to reinvest the dividend for growth? Consider your business’s growth trajectory and potential expansion plans.
Market Position: Is your industry stable or growing? A strong market position can make lenders more comfortable with a dividend recap.

For example, when Heads-Up Technologies, a manufacturer of aviation components, completed a $56.4 million dividend recap in April 2024, it likely did so from a position of financial strength in a growing aviation industry.

2. Risk Tolerance

Dividend recaps increase your company’s leverage, which can amplify both returns and risks:

Economic Sensitivity: How would your business fare in a downturn with increased debt? Model various economic scenarios to understand your risk exposure.
Covenant Compliance: Can you comfortably meet the terms of the new debt? Be sure to understand all covenants and their implications for your business operations.

Caution: The case of Neiman Marcus, which went through multiple dividend recaps before eventually filing for bankruptcy, serves as a cautionary tale about the risks of excessive leverage.

3. Strategic Objectives

Consider how a dividend recap aligns with your long-term goals:

Exit Strategy: Does this move prepare your company for a future sale or IPO? A dividend recap can demonstrate your company’s ability to handle leverage, potentially making it more attractive to future buyers or investors.
Growth Plans: Will the dividend fund expansion or acquisitions? If so, ensure that the potential returns from these initiatives justify the increased leverage.
Shareholder Needs: Are there shareholders seeking liquidity? A dividend recap can be an effective way to provide returns to shareholders without changing the ownership structure.

The dividend recap of Petco in 2016, which preceded its eventual IPO, is an example of how this strategy can be part of a larger strategic plan.

4. Market Timing

Assess current market conditions:

Interest Rates: Are rates favorable for borrowing? While rates are still relatively low, they have been rising, so timing can be crucial.
Lender Appetite: Is there strong demand for dividend recap deals in your industry? This can affect the terms you’re able to negotiate.

The increase in dividend recaps in 2023 and early 2024, as seen in our transaction list, suggests a favorable market for these deals, but conditions can change quickly.

5. Alternative Options

Compare a dividend recap to other strategies:

Traditional Financing: Would a standard loan or line of credit suffice? These might offer lower transaction costs and less complexity.
Equity Sale: Is selling a minority stake a better option? This could provide capital without increasing leverage, but at the cost of dilution.
Organic Growth: Could reinvesting profits yield better long-term results? Sometimes, the best use of capital is within the business itself.

Structuring Your Dividend Recap

The structure of your dividend recap can significantly impact its success. Here are some key elements to consider:

1. Debt Composition

Your recap might involve different types of debt:

Senior Secured Debt: This is typically the least expensive but most restrictive form of debt.
Subordinated Debt: While more expensive, it can provide additional flexibility.
Revolving Credit Facility: This can provide ongoing liquidity alongside the term debt used for the dividend.

For example, the dividend recap of Clarity SSI involved both a term loan and a revolving credit facility, providing both immediate capital and ongoing flexibility.

2. Covenant Structure

Covenants are a crucial part of any debt agreement. Common types include:

Financial Covenants: These might include leverage ratios, interest coverage ratios, or minimum EBITDA requirements.
Negative Covenants: These restrict certain actions, like additional borrowing or asset sales.
Affirmative Covenants: These require specific actions, like providing regular financial reports.

Work with your advisors to negotiate covenants that provide adequate protection for lenders while maintaining operational flexibility for your business.

3. Repayment Terms

Consider the following:

Amortization Schedule: How quickly will you need to repay the principal?
Prepayment Penalties: Are there restrictions on paying off the debt early?
Interest Rate Structure: Fixed vs. variable rates can significantly impact your long-term costs.

4. Use of Proceeds

While the primary purpose is to pay a dividend, consider reserving some capital for:

Working Capital: To ensure ongoing liquidity.
Growth Initiatives: To demonstrate to lenders that you’re reinvesting in the business.
Debt Service Reserve: To provide a cushion for debt payments.

Mitigating Risks

While dividend recaps can offer significant benefits, they also come with risks. Here are strategies to mitigate these risks:

1. Solvency Opinions

Consider obtaining a solvency opinion from a qualified financial advisor. This independent assessment can:

Provide legal protection against potential fraudulent transfer claims
Offer assurance to lenders and other stakeholders
Reveal valuable insights about your company’s financial position

While our transaction list doesn’t specify which companies obtained solvency opinions, it’s a common practice in larger transactions and can be valuable even for smaller deals.

2. Conservative Structuring

Work with your financial advisors to structure the recap conservatively:

Maintain adequate cash reserves
Ensure reasonable debt service coverage ratios
Consider including flexible terms like payment-in-kind (PIK) options

For example, the dividend recap of LBB Specialties, a distributor of specialty chemicals, involved a relatively modest $22.5 million transaction, suggesting a conservative approach to leverage.

3. Scenario Planning

Conduct thorough scenario analysis:

Model various economic and industry-specific scenarios
Assess your company’s ability to weather downturns with the new debt structure

This is particularly important in cyclical industries. For instance, companies in the energy sector, like Generation Bridge, need to consider how fluctuations in energy prices might affect their ability to service debt.

4. Clear Communication

Maintain transparent communication with all stakeholders:

Explain the rationale behind the dividend recap
Address concerns from employees, customers, and suppliers

Clear communication can help maintain confidence in your company’s financial health and strategic direction.

Tax Implications of Dividend Recaps

The tax treatment of a dividend recap can significantly impact its overall benefit. While tax laws can vary by jurisdiction and change over time, here are some general considerations:

For the Company

Interest Deductibility: In many jurisdictions, the interest on the new debt is tax-deductible, potentially lowering your company’s tax burden. This can partially offset the cost of the dividend recap.
Capitalization Rules: Be aware of thin capitalization rules that may limit interest deductibility if your debt-to-equity ratio becomes too high. These rules vary by country and can significantly impact the tax efficiency of your recap.

For Shareholders

Dividend Tax Rates: In some jurisdictions, dividends may be taxed at a lower rate than capital gains, making a recap more attractive than a sale of shares. For instance, in the United States, qualified dividends are often taxed at preferential rates.
Basis Implications: The dividend may reduce the tax basis in the shareholders’ stock, which could impact future capital gains calculations. This is particularly relevant if a sale of the company is contemplated in the near future.

Important: Always consult with tax professionals to understand the specific implications for your company and shareholders. Tax laws are complex and can vary significantly based on your jurisdiction and specific circumstances.

Industry-Specific Considerations

While dividend recaps can be utilized across various sectors, the nuances of your specific industry can significantly impact the feasibility and structure of such a transaction. Let’s explore some industry-specific considerations:

Manufacturing and Industrial

Companies in the manufacturing sector, like 8020.net and Waupaca Foundry, have successfully executed dividend recaps. Key considerations for this sector include:

Capital Intensity: Manufacturing often requires significant capital investment. Ensure that a dividend recap doesn’t compromise your ability to maintain or upgrade essential equipment.
Cyclicality: Many manufacturing subsectors are cyclical. Structure your recap to withstand potential downturns in demand.
Supply Chain Dynamics: Consider how changes in your financial structure might impact relationships with suppliers and customers.

Technology and Software

Tech companies like Greenhouse.com and Cyara.com have leveraged dividend recaps effectively. Industry-specific factors to consider include:

Growth Trajectory: Ensure the recap doesn’t hinder your ability to invest in R&D or pursue rapid growth opportunities.
Valuation Multiples: Tech companies often trade at high multiples. A recap can be an attractive way to realize some of this value without dilution.
Intellectual Property: Lenders may place significant value on your IP. Ensure your recap doesn’t compromise control over these crucial assets.

Healthcare and Services

GHR Healthcare and Viking Cloud demonstrate the applicability of dividend recaps in service-oriented businesses. Consider:

Regulatory Environment: Ensure the recap doesn’t impact your ability to comply with industry regulations.
Human Capital: For service businesses, your workforce is a key asset. Structure the recap to maintain competitive compensation and benefits.
Scalability: Many service businesses are highly scalable. A recap can provide capital for rapid expansion.

Energy and Infrastructure

Companies like Generation Bridge and Hess Midstream show how dividend recaps can work in capital-intensive industries. Key factors include:

Long-term Contracts: Many energy companies have long-term revenue contracts. These can provide stability that makes lenders more comfortable with a recap.
Regulatory Considerations: Energy and infrastructure are often heavily regulated. Ensure the recap complies with all relevant regulations.
Environmental Factors: With increasing focus on ESG, consider how a recap might impact your ability to transition to more sustainable practices.

The Role of Private Equity in Dividend Recaps

Private equity firms have been significant drivers of the dividend recap trend. If you have PE investors, or are considering PE investment, understanding their perspective is crucial:

PE Objectives

Return Generation: PE firms use dividend recaps to generate returns for their limited partners without exiting the investment entirely.
Portfolio Company Optimization: Recaps can optimize the capital structure of portfolio companies, potentially improving returns.

Impact on Non-PE Owned Companies

Even if your company isn’t PE-owned, their influence has shaped the market:

Increased Acceptance: The frequent use of dividend recaps by PE firms has made them more mainstream and accepted by lenders.
Sophisticated Structuring: PE firms have pushed for more complex and borrower-friendly structures, which can benefit all companies in the market.

Common Pitfalls to Avoid

While dividend recaps can be powerful tools, they come with potential pitfalls. Here are some to watch out for:

Overleveraging: Taking on too much debt can leave your company vulnerable to economic downturns or industry disruptions.
Neglecting Growth: Ensure that the recap doesn’t come at the expense of necessary investments in your business’s future.
Misjudging Market Conditions: Timing is crucial. A recap that makes sense in a strong economy might be risky if conditions are deteriorating.
Underestimating Operational Impact: New debt often comes with reporting requirements and covenants that can impact day-to-day operations.
Failing to Align Stakeholders: Ensure all shareholders, board members, and key management are aligned on the strategy.

Case Study: A Successful Dividend Recap

Let’s examine a hypothetical case study based on trends observed in our transaction list:

TechServe Solutions, a mid-sized IT services company, completed a $50 million dividend recap in 2023. Here’s how they approached it:

Preparation: They spent six months improving their financial reporting and developing robust projections.
Timing: They executed the deal when their industry was showing strong growth and lender appetite was high.
Structure: They secured a $40 million term loan and a $10 million revolving credit facility, providing both immediate liquidity and ongoing flexibility.
Use of Proceeds: 80% was distributed to shareholders, while 20% was retained for growth initiatives.
Risk Mitigation: They obtained a solvency opinion and implemented new financial monitoring systems to ensure covenant compliance.
Outcome: The recap allowed the founding shareholders to realize some value while maintaining control. The company used the retained capital to fund an acquisition, accelerating its growth.

Future Outlook for Dividend Recaps

Looking ahead, several factors could influence the landscape for dividend recaps:

Interest Rate Environment: If interest rates continue to rise, it could impact the attractiveness of dividend recaps. However, as long as rates remain historically low, these transactions are likely to remain popular.
Regulatory Changes: Keep an eye on potential changes in tax laws or financial regulations that could affect the viability of dividend recaps.
Economic Conditions: A significant economic downturn could reduce lender appetite for these transactions, while continued growth could fuel more deals.
Industry-Specific Trends: Some industries may see increased activity in dividend recaps as they mature or consolidate.

Conclusion

The resurgence of dividend recapitalizations in 2024 presents an intriguing opportunity for company owners across various industries. While these transactions can offer significant benefits—including unlocking value, optimizing capital structures, and providing liquidity—they also come with risks that must be carefully managed.

As a business owner, your decision to pursue a dividend recap should be based on a thorough assessment of your company’s financial health, strategic objectives, and risk tolerance. It’s crucial to work closely with experienced financial advisors and legal counsel to structure a transaction that aligns with your goals while safeguarding your company’s long-term stability and growth prospects.

Key Takeaway: A well-executed dividend recap can be a transformative strategy, but it requires careful planning, expert guidance, and a clear understanding of your company’s unique circumstances.

By staying informed about market trends, carefully evaluating your options, and implementing robust risk mitigation strategies, you can make a well-informed decision about whether a dividend recap is the right move for your business in today’s dynamic financial landscape.

Remember, while dividend recaps can be a powerful tool, they’re not suitable for every company. Your unique circumstances, industry dynamics, and long-term vision should guide your decision-making process. With the right approach, a dividend recap could be the key to unlocking new opportunities for growth and value creation in your business.