Private equity can't sell companies, so it's taking debt dividends
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Private equity's exit drought has led to a record number of dividend recaps, which is when PE funds pay themselves to kick the debt grenade down the road and into a storm drain.
- A more academic description would be that PE-backed companies issue new debt and use some/most/all of the proceeds to pay shareholders a dividend.
By the numbers: Such transactions were valued at $33.4 billion through last Friday, according to PitchBook LCD.
- That tops the $32 billion year-to-date peak from 2013, and the $31.2 billion mark from 2021.
The big picture: Dividend recaps wouldn't normally spike in a higher-rate environment, but this is what happens when PE funds are unable or unwilling to sell their swollen portfolios.
- Limited partners have gotten more vocal about demanding distributions, and this is a way for general partners to keep the pitchforks at bay (and new fund commitments flowing).
- It's actually a bit ironic, as PE funds often used to do dividend recaps as a way to pay themselves before paying LPs, but that noxious practice has mostly subsided.
Why it matters: These deals are habitually horrible for the actual portfolio companies and their employees, particularly if rates remain high and/or the economy slows.
- PE pros sometimes equate dividend recaps to home equity loans, but it's a bad comp.
- If a home equity loan goes sour, it's a financial problem for the person who decided to take out the loan. The house itself is fine. In dividend recaps, the "decider" can just walk away while the underlying asset suffers.
- Yes, private equity owners still want their portfolio companies to appreciate after a dividend recap. But some of the incentive has been removed, particularly if the general partner has newer and shinier opportunities.
The bottom line: We know that dividend recaps are on the rise, but we'll have to wait to learn the consequences.
