Private equity firms’ reliance on dividend recapitalization has reached historic highs, with $30.2 billion raised in leveraged loans for dividend recaps in the first half of 2024 alone.
In recent years, private equity firms have seen a significant surge in borrowing money to pay investors through dividend recapitalization, a practice where companies borrow funds to distribute cash dividends to shareholders.
According to PitchBook LCD data, this trend reached record levels in 2024, with $30.2 billion raised in leveraged loans for dividend recaps in the first half of the year alone.
Private equity firms are investment companies that acquire ownership stakes in privately held companies.
They use a combination of debt and equity to finance the acquisition, with the goal of eventually selling the company for a profit.
Private equity firms often invest in companies that are undervalued or have growth potential, and they work to improve their operations and increase their value before selling them.
A Perfect Storm of Market Conditions
The resurgence can be attributed to a combination of factors. During the Covid-19 pandemic, low interest rates and heavy fiscal stimulus allowed private equity firms to raise funds from limited partners (LPs) – investors in private equity funds – and borrow at record levels.
However, this was followed by high inflation, stricter regulatory regimes, and higher interest rates that made it harder for potential buyers of portfolio companies to finance acquisitions.
Consequences of High Leverage
The use of dividend recapitalization comes with a cost. Heightened leverage makes companies more vulnerable in uncertain economic environments, as seen in the case of Wheel Pros, backed by Clearlake Capital.
After executing a dividend recap in 2020, Wheel Pros‘ financial leverage ballooned to over seven times its earnings in 2021.
When sales declined in 2022, earnings plummeted 86 percent, leading to multiple credit downgrades.
The Risks and Consequences
Despite the risks, private equity firms continue to rely on dividend recapitalization to pay investors. Blackstone‘s $1.7 billion refinancing of Park Place Technologies and Centerbridge Partners’ $925 million loan for KIK Custom Products are just two examples of firms leveraging debt markets to fund investor payouts.
However, if economic conditions worsen or more companies follow Wheel Pros’ trajectory, lenders may become more cautious, and the window for dividend recaps could close quickly.
A Defining Question for 2025
Whether private equity firms can sustain their reliance on high-yield credit remains to be seen.
As ‘these deals heap pressure on borrowers who are already rated below investment grade’, Moody’s has warned, these deals heap pressure on borrowers who are already rated below investment grade.
Companies that take on excessive debt to pay dividends risk financial distress if business conditions deteriorate.
The coming year will likely hold the answer to this question.
