Dividend Recapitalizations, Explained
The question
During a five-year LBO hold, the sponsor executes a $40 million dividend recap at the end of year 3, funded by additional subordinated debt. Entry data: EBITDA $50 million, multiple 8.0x, initial net debt $280 million. Exit data: EBITDA $80 million, multiple 10.0x. Over the hold, the company amortizes $60 million of original debt. Exit net debt is $260 million (includes the recap debt). The sponsor invested the full entry equity and retains 100% ownership. Construct the value-creation bridge, then compute total sponsor proceeds including the dividend. Explain why the dividend does not appear as a separate value driver.
General educational practice only. This is not an actual, confidential, leaked, or firm-provided interview question. Check important technical details against primary learning materials.
Study explanation
Entry EV = 8.0 x $50M = $400M. Entry equity = $400M - $280M = $120M. Sponsor check = $120M. Exit EV = 10.0 x $80M = $800M. Exit equity = $800M - $260M = $540M. Equity gain = $540M - $120M = $420M.
Bridge components:
- EBITDA growth: ($80M - $50M) x 8.0 = $240M
- Multiple expansion: (10.0 - 8.0) x $50M = $100M
- Cross-term: ($80M - $50M) x (10.0 - 8.0) = $60M
- Net debt reduction: $280M - $260M = $20M (positive because amortization of $60M exceeded the recap debt of $40M) Sum = $240M + $100M + $60M + $20M = $420M, ties.
Total sponsor proceeds: $40M dividend at year 3 + $540M exit equity at year 5 = $580M. MoIC = $580M / $120M = 4.83x. The bridge measures the change in the company's equity value on its balance sheet; the dividend is a distribution of that value, not a source of new value. The $40M recap is reflected in the bridge via the net debt reduction component: without the recap, exit net debt would have been $220M ($280M - $60M), and net debt reduction would have been $60M, adding $40M more to equity gain. The total MoIC would still be 4.83x because the same total enterprise value and operations produce the same total proceeds, just with different timing.
Follow-up pressure:
- Estimate the IRR with and without the recap using the weighted-average-life approximation. How many basis points does the recap add?
- If the recap debt carried a 2% OID and $2M in fees, what is the net cash received by the sponsor and the true exit net debt? Recalculate MoIC.
- Suppose the recap debt was a toggle note with 8% PIK and no cash interest, and it all accreted to year 5. How would exit net debt change, and does the MoIC still equal the no-recap scenario?
Sources & uses
| Term Loan B | 400 |
| Senior notes | 250 |
| Sponsor equity | 370 |
| Total sources | 1,020 |
| Purchase of equity | 900 |
| Refinance existing debt | 100 |
| Financing & advisory fees | 20 |
| Total uses | 1,020 |
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The rest of this topic
LBO returns: IRR, MoIC and the value bridge