What Does Dividend Recapitalization Mean?
Dividend recapitalization is a private equity practice where a special dividend is paid to private shareholders to help them recoup a part of their money invested in the firm. The dividend recapitalization reduces the risk for investors because they get to take out some of their investment. However, this practice is not always favorable to the organization because it piles on more debt to benefit a few stakeholders. Also, it reduces the credit quality of the company in the eyes of its creditors.
Divestopedia Explains Dividend Recapitalization
The idea of dividend recapitalization is best explained with an analogy. Suppose there are three friends who get together to buy a house with the aim to flip it. They put in some of their money and borrow the remaining from the bank. In some amount of time, they renovate the house and flip it for a profit. They pay off the bank loan and share the remaining profits among themselves.
However, if they decide to wait for a few more years before selling in the hope that the real estate market will go up, then their funds are locked up. To free up their capital, they take a second mortgage on the house based on the increased value of the property and divide this money among themselves. In this way, the three friends get some or all of their money back, thereby reducing their risk in the investment. As for the bank loan, they repay it from the proceeds of the sale. If they fail, the bank simply gets to repossess the house, but the investors have had their share of profits.
This is exactly how a dividend recapitalization works too. It benefits the investors, but saddles the organization with debt. Though the exact burden varies based on how much is paid out to investors, the success of this practice depends to a large extent on the credit standing and financial position of the business. In general, it does not benefit the company because this practice makes it more susceptible to changing market conditions and can even lead to bankruptcy.