How to Answer “What is a dividend recap and when would you do one?” in Private Equity Interviews

Start with a crisp definition: a dividend recapitalisation is when a portfolio company raises incremental debt (or refinances into a larger debt package) and uses the proceeds to pay a dividend or distribution to shareholders, typically the PE sponsor. The business hasn’t been sold; it’s a mid-hold capital structure change.

Then state the purpose in plain language: it’s a way to return capital early, de-risk the sponsor’s equity, and potentially improve the fund’s IRR while keeping ownership and upside. Add one clarifier that shows maturity: a recap can be a “dividend recap” (cash out) or a broader recap/refi to reprice debt, extend maturities, or fund growth—dividends are just one use of proceeds.

Keep it interview-tight: no long history lesson, just the mechanics and the goal.

Lay out the “when to use a dividend recap” checklist sponsors and lenders care about:

• Business performance: the company has outperformed plan, has predictable free cash flow, and can service higher interest expense through the cycle.
• Credit market window: debt is available at acceptable pricing/terms; there’s lender appetite for the story (often with strong sponsor support and credible forecasts).
• Capacity and constraints: leverage after the recap is still reasonable for the sector; fixed-charge coverage and covenant headroom remain comfortable; maturities are not bunched.
• Use-of-proceeds trade-off: the distribution doesn’t starve the business—capex, working capital, and growth initiatives still get funded.
• Investment thesis alignment: a recap is consistent with the value-creation plan (e.g., operational improvements delivered; remaining upside still meaningful) rather than masking weak performance.

Frame it as capital structure interview prep: it’s about optimising risk-adjusted returns, not maximising leverage by default.

Explain the impact in three buckets:

1. Returns: paying a dividend reduces the sponsor’s invested equity and brings cash forward, typically increasing IRR (time value) and sometimes improving MOIC on remaining invested equity. However, the enterprise value doesn’t magically rise—value is being reallocated between debt and equity.

2. Risk and flexibility: higher leverage increases default risk, reduces resilience to a downturn, and can limit strategic options (capex, add-ons, pricing pressure). Mention second-order effects: higher interest expense reduces free cash flow available for deleveraging.

3. Stakeholders: lenders focus on credit metrics, covenants, and downside protection; management may like the signal of confidence but worry about underinvestment; the sponsor balances early distributions against the probability-weighted exit outcome.

This is where you show judgement: discuss what could go wrong and what protections you’d want (maturity runway, cov-lite vs maintenance covenants, liquidity).

Use quick numbers to make it concrete (no need for a full model):

• Suppose a company bought at £500m EV with £300m debt / £200m equity. After two years of strong performance, it can raise an extra £75m of term debt and pay a £75m dividend.
• Debt increases to £375m and sponsor has now returned £75m cash while still owning the equity.

Then add sanity checks that interviewers expect in dividend recap examples:

• Post-recap leverage and coverage still work under a downside case (revenue/margin compression, higher rates).
• Liquidity is adequate (revolver availability, cash balance policy).
• The recap doesn’t break the operational plan (capex/working capital needs) and doesn’t force an early exit at an inopportune time.

Close by noting that in real dividend recap case studies, the decision often hinges on the durability of cash flows and whether the market is paying for risk appropriately.