Module IV· Cash SweepAdvanced
Question
What is a 'recap dividend' and when is it reflected in the LBO model?
Answer
Mechanics
A recap (recapitalization) dividend = the sponsor pulls cash out of the HoldCo, often funded by new debt or accumulated cash. It reduces sponsor risk and raises IRR.
Deep diveShow more details
Example setup
The sponsor invested $150m of equity in Year 0. After 3 years: debt reduced from 200 → $100m, EBITDA grown from 40 → $55m.
Recap mechanics
| Item | Pre-recap | Recap | Post-recap |
|---|---|---|---|
| Total Debt | 100 | +75 (new TLB) | 175 |
| Debt/EBITDA | 1.8x | — | 3.2x |
| Recap dividend to sponsor | — | 75 | — |
| Sponsor cash-out, cumulative | 0 | +75 | 75 |
| Equity at Risk | 150 | − 75 | 75 |
Consequence
The sponsor has 50% of its equity back — IRR rises sharply, because:
- An earlier cash distribution = higher time value
- Reduced equity-at-risk = a higher multiple at exit
Common pitfalls
- A recap raises leverage back to a higher level — operating risk goes up
- Tax: a recap dividend can trigger special taxes (a participation-exemption test in many jurisdictions)
- Lender consent is needed — the restricted-payments clause in the credit agreement
Pitch tip
Question: "When is a recap rational?"
Answer: "When leverage has fallen below 2.5x EBITDA AND the market for new debt is favorable AND the exit is still 2-3 years out. Classically Year 3-4 in a 5-7 year hold"