Dividend recapitalization (or “recap") is a concept utilized in the private equity space and beyond, stemming from conditions wherein a company cannot raise capital through a public offering, resulting in cash retention. Dividend recapitalization serves as a substitute for a traditional IPO.

In essence, dividend recapitalization occurs when a private equity (PE) firm issues new debt in order to raise capital and issue a dividend to shareholders. The only difference between this and a traditional dividend is that dividend recapitalizations come from a form of private capital invested in the company, rather than generated by the company's operations.

In a typical dividend recapitalization, a PE firm issues new debt to take out existing debt, restructure multiple debts, acquire new debt and make payments on existing debt. When this is done, the firm then uses the newly-raised capital to pay out a dividend to its shareholders. This type of financing enables the PE firm to still have control over the company while ameliorating the firm's own liquidity needs.

Typically, a PE firm will only utilize dividend recapitalization if the costs of that debt are lower than the rate of return on the equity investments. It is important to note, however, that there are various cons associated with recapitalization, most notably its risk of overleveraging the company. Dividend recapitalization significantly increases the debt on the portfolio company’s balance sheet and, should their earnings be low, the company may struggle to repay its new debt.

Overall, a dividend recapitalization is a unique financial maneuver that enables a PE firm to reap a return on their investments without having to resort to a more traditional and potentially more costly alternative, such as an IPO. Although a certain amount of risk is associated with it, using this strategy judiciously can be incredibly beneficial.