casemark/modeling-dividend-recapitalizations

Modeling Dividend Recapitalizations

Structures dividend recap analysis with leverage impact, credit agreement compliance, and return enhancement calculation.

When To Use

• Sponsor is considering an interim cash distribution funded by incremental debt prior to exit
• Evaluating whether a portfolio company can support additional leverage for a dividend recap
• Comparing a dividend recap against alternative liquidity events (partial sale, secondary, continuation fund)
• Stress-testing credit agreement headroom before approaching lenders for recap financing
• Quantifying IRR and MOIC enhancement from accelerating cash-on-cash returns

Inputs To Gather

• Current capital structure: Senior debt outstanding (revolver drawn, term loan balances), subordinated/mezzanine layers, total equity invested at cost
• Credit agreement terms: Maximum leverage ratio (Total Debt / EBITDA), secured leverage cap, fixed charge coverage minimum, restricted payments basket language, pro forma incurrence test thresholds [VERIFY against actual credit agreement]
• Company financials: Trailing twelve-month (TTM) EBITDA, forward projections (2–3 years), capex requirements, working capital seasonality, cash on balance sheet
• Proposed recap parameters: Target dividend amount, proposed new debt instrument (term loan B, second lien, holdco PIK), indicative pricing (spread, OID, floor), expected tenor
• Sponsor economics: Equity check at entry, any prior distributions, current fund vintage and deployment pace, LP reporting considerations

Workflow

1. Establish pre-recap baseline

   • Build or refresh the operating model with TTM financials and management projections
   • Calculate current leverage (Total Debt / EBITDA, Net Debt / EBITDA, Senior / EBITDA)
   • Compute current free cash flow profile and debt service coverage ratio (DSCR)

2. Size the dividend

   • Determine maximum incremental debt capacity under credit agreement covenants
   • Apply the restricted payments basket test — identify whether the dividend falls within builder basket, general basket, or requires an incurrence-based exception [VERIFY covenant language for specific permitted payment carve-outs]
   • Deduct transaction fees (arrangement fees, legal, advisory) from gross proceeds to derive net distributable amount
   • Sense-check dividend size against market comps for similar recap transactions (typically 1.0×–2.5× incremental turns of leverage)

3. Model pro forma capital structure

   • Layer in new debt tranche with proposed terms (rate, amortization, maturity, call protection)
   • Recalculate blended cost of debt and weighted average maturity
   • Produce pro forma leverage and coverage ratios at close and for each projected period
   • Confirm no covenant breach at closing or within the projection horizon under the base case

4. Assess credit impact

   • Run downside scenarios: revenue decline of 10–20%, margin compression of 100–300 bps, working capital blow-out
   • Identify the EBITDA breakeven level at which covenant thresholds are breached
   • Calculate cushion percentages on each financial covenant post-recap
   • Evaluate rating agency implications if applicable (Moody's/S&P leverage thresholds for the sector) [VERIFY sector-specific rating benchmarks]

5. Quantify return enhancement

   • Recalculate sponsor IRR and MOIC with the dividend included as an interim cash flow
   • Compare gross and net IRR/MOIC pre- and post-recap across multiple exit timing scenarios (e.g., exit in Year 3, 4, 5)
   • Compute DPI (distributions to paid-in) impact on fund-level metrics
   • Show cash-on-cash return at the time of the dividend (dividend ÷ equity invested)

6. Sensitivity and scenario analysis

   • Build a two-way sensitivity table: dividend size vs. exit EBITDA multiple
   • Vary interest rate assumptions (fixed vs. floating, hedge cost) to stress debt service
   • Model early repayment of recap debt from excess cash flow to show deleveraging trajectory
   • Present bear/base/bull return profiles with and without the recap

Output

• Executive summary: One-page overview of proposed recap — dividend amount, pro forma leverage, covenant headroom, and IRR/MOIC enhancement
• Pro forma capitalization table: Pre- and post-recap side-by-side with all debt tranches, rates, maturities, and total equity value
• Covenant compliance matrix: Each financial covenant tested at close and through the projection period with cushion percentages
• Returns waterfall: Sponsor IRR and MOIC with and without recap, across exit timing scenarios
• Sensitivity tables: Dividend size vs. leverage, EBITDA decline vs. covenant breach, exit multiple vs. IRR
• Risk flags: Identified risks including refinancing exposure, floating rate sensitivity, and covenant tightness

Quality Checks

• Pro forma leverage ratios tie exactly to the credit agreement definitions (confirm EBITDA add-backs, pro forma adjustments match lender methodology) [VERIFY]
• Restricted payments test uses the correct basket and references the operative credit agreement section
• IRR calculations use actual cash flow dates — not period-end approximations
• All incremental debt terms reflect current market conditions for the company's credit profile
• Downside scenarios are genuinely stressful, not cosmetic — test at least a 15% EBITDA decline
• Dividend amount plus fees plus minimum cash does not exceed gross debt proceeds
• Model cross-checks: ending cash balance ties to cash flow statement, debt schedule ties to balance sheet, interest expense ties to average balances × applicable rates