Structure
Dividend recapitalisation
A dividend recap refinances the company onto a larger facility and pays the surplus to shareholders, so owners take cash out without selling. It has to pass two independent tests: whether the cash flow carries the new leverage, and whether distributable reserves cover the dividend.
Also called dividend recap · debt-funded dividend · recap · leveraged dividend
New borrowing raises cash but creates no profits. The bank balance moves and the distributable reserves do not.
| Measure | Change |
|---|---|
| Cash | £5m |
| Distributable reserves | £0m |
Illustrative on a company borrowing an additional £5m. Distributable reserves are governed by Part 23 of the Companies Act 2006; borrowing is a liability matched by an asset, so it adds nothing to accumulated realised profits. Not legal or tax advice.
What it is
A refinancing onto a larger debt facility, with the surplus paid to shareholders as a distribution, so owners take cash out without selling.
Nothing about the ownership changes. The same people own the same shares in the same company the day after. What has changed is the capital structure: more debt, less equity value, and a payment that has already left.
The reason it exists is that a successful private company can be worth a great deal on paper while its owners have no way to realise any of it short of a sale. A recap converts part of that paper value into cash without introducing a buyer, a process, or a new shareholder.
The two tests
One commercial, one legal, and they are entirely independent of each other. A recap fails if either fails.
The commercial test is whether the cash flow carries the new leverage in a downside case, not just in the plan. This is the lender's question, and it is asked in the same way as on any facility, with the difference that the money raised is leaving rather than being invested in something that might generate a return.
The legal test is distributable reserves. The dividend must be covered by distributable reserves under Part 23 of the Companies Act 2006. This is a question about the company's accumulated realised profits, and it has nothing whatever to do with how much cash is in the bank.
It is common to satisfy one and fail the other, which is why both belong in the feasibility conversation at the start rather than emerging at completion.
Lenders price the purpose. Money that leaves the business is read differently from money that stays in it.
| Term | How much it changes |
|---|---|
| Interest margin | 4–24 on the scale |
| Covenant headroom | 35–58 on the scale |
| Leverage level permitted | 52–76 on the scale |
| Distribution restrictions | The next one is controlled |
What tightens in the documents when the purpose of a facility is a distribution rather than an investment. Illustrative of market practice; the guides publish no recap-specific covenant schedule.
Why borrowing creates no reserves
Because a loan is a liability matched by an asset, and neither is a profit. This is the point that surprises most owners.
Draw an additional £5m and the cash goes up by £5m. The distributable reserves go up by nothing, because nothing has been earned. Reserves are accumulated realised profits less realised losses, and a borrowing is neither.
So a company can hold the cash to pay a dividend and still be unable to pay one lawfully. The money is there and the legal capacity is not.
Where reserves fall short, a solvency-statement capital reduction can create them. That is a real and well-established route, and it needs proper advice, a directors' solvency statement and the statutory process rather than a resolution and a payment. It is also not instant, so it belongs in the timetable from the start.
What lenders want to see
Stable, cash-generative earnings, and a structure that stays conservatively levered after the money has gone.
The businesses that get recaps funded are the ones a lender would be comfortable lending to anyway: predictable revenue, real cash conversion, no cliff-edge customer or contract risk, and a management team that will still be there.
The specific expectation is leverage inside acquisition levels afterwards. A lender is not looking to fund a business to the top of its appetite when the proceeds leave, because the cushion that protects them has just been paid away.
There is a third condition that is easy to overlook and matters as much as the numbers: a meaningful stake stays in. A recap where the owners take out most of what they have and remain to run the business reads very differently from one where they take out a portion and stay heavily invested in the outcome. The lender is buying the alignment as much as the earnings.
How it prices
Close to a plain refinancing on rate, and meaningfully tighter in the documents. Lenders price the purpose.
The margin does not usually move far, because the credit is the same business it was last month. What moves is everything that controls what happens next: covenant headroom set more conservatively, a leverage level expected to sit inside acquisition levels, and distribution restrictions that are considerably tighter than on a facility funding an investment.
That last one is the change borrowers notice most. A lender that has just funded one payment to shareholders will control the next one closely, so expect a permitted payments schedule that is specific, conditional on leverage, and unlikely to allow a repeat without consent.
None of that makes a recap expensive. It makes it a facility with less room in it, which is the right way to think about the trade being made.
The same downside year lands very differently depending on where the recap left you. This is how a stable business becomes a fragile one.
| Recapped at | Leverage after a 20% fall |
|---|---|
| 2.5x (£5m) | 3.13x |
| 3.5x (£7m) | 4.38x |
Derived arithmetic on £2m of EBITDA within the published bank senior 2.5-3.5x band, with earnings falling 20% to £1.6m. Sized at the top of the band the recap leaves leverage above it after one bad year; sized at the bottom it does not.
The sizing discipline
Size it on the downside case, with covenant headroom intact afterwards. This is the whole of the difference between a sensible transaction and a dangerous one.
Take a business with £2m of EBITDA. Recapped to two and a half times it carries £5m of debt; if earnings fall twenty per cent to £1.6m, leverage becomes 3.13 times, still inside the published bank senior range of two and a half to three and a half times. Recapped to three and a half times it carries £7m, and the same fall takes leverage to 4.38 times, above the range entirely.
The business is the same in both cases and so is the bad year. The difference was a decision taken twelve months earlier, in a good year, about how much to take out.
Sized on a downside case with covenant headroom, a recap is a legitimate tool. Sized to the maximum in a good year, it is how stable businesses become fragile.
The timing question
The best moment to do one is usually not the moment it feels most attractive, and that tension is worth naming.
A recap looks best after a strong year, when EBITDA is at a high, the multiple applies to a large number and the maximum available is at its most tempting. That is precisely the moment when the trailing twelve months most overstate the durable earning power of the business.
A lender running its own downside case is protecting itself against exactly that. The borrower's version of the same discipline is to ask what the facility looks like if this year turns out to have been the peak, and to size against that answer rather than against the number the multiple produces.
The practical test is simple: would you be comfortable with this facility if next year's EBITDA were the average of the last three rather than the last one? If not, take less.
When the answer is to leave the cash in
More often than the availability of the money suggests, and an adviser who never says this is not being useful.
Where the business needs the capital for something identified, a recap competes directly with that use and usually loses, because equity taken out is the most expensive capital to replace later.
Where the earnings are cyclical or the customer base is concentrated, the fixed obligation created by the new debt sits badly against revenue that is not fixed, and the recap converts a variable problem into a solvency one.
And where the owners are contemplating a sale in the next two or three years, a recap can complicate it: a buyer sees a more leveraged business, the debt has to be refinanced or repaid on the transaction, and the cash taken out is cash the buyer is no longer paying for.
The honest framing is that a recap trades future flexibility for present cash. That is a reasonable trade when the present cash has a purpose and the future has room in it, and a poor one otherwise.
Common questions
What is a dividend recapitalisation?
A refinancing onto a larger debt facility with the surplus paid to shareholders as a distribution, so owners take cash out without selling. The ownership is unchanged; what changes is the capital structure and the fact that a payment has left the business.
Can I take money out of my business without selling it?
Often yes, if the leverage holds. It has to pass two independent tests: the commercial one, whether the cash flow carries the new leverage in a downside case, and the legal one, whether distributable reserves cover the dividend under Part 23 of the Companies Act 2006.
Why do I need distributable reserves if I have the cash?
Because new borrowing raises cash but creates no profits. A loan is a liability matched by an asset, and reserves are accumulated realised profits less realised losses. So a company can hold £5m of newly drawn cash and have gained no legal capacity to pay a dividend at all.
What if my distributable reserves fall short?
A solvency-statement capital reduction can create them. It is a well-established route requiring proper advice, a directors' solvency statement and the statutory process rather than a resolution and a payment, and it takes time, so it belongs in the timetable from the start. Not legal advice.
Which businesses do lenders fund recaps for?
Stable, cash-generative ones that stay conservatively levered afterwards, with leverage inside acquisition levels rather than at the top of appetite. Lenders also want a meaningful stake to stay in, because the alignment matters as much as the earnings when the proceeds are leaving the business.
Does a recap cost more than a normal refinancing?
Not much on rate, since the credit is the same business. What tightens is the documents: more conservative covenant headroom, a lower permitted leverage level, and considerably tighter distribution restrictions, because a lender that has just funded one payment to shareholders will control the next closely.
How much should I take out?
Size it on the downside case. On £2m of EBITDA, a recap at 2.5 times leaves leverage at 3.13 times after a 20% fall in earnings, still inside the bank senior range. At 3.5 times the same fall takes it to 4.38 times, outside it. A useful test: would you be comfortable if next year's EBITDA were the average of the last three?
When should I not do one?
Where the business needs the capital for something identified, where earnings are cyclical or customers concentrated so a fixed obligation sits badly against variable revenue, or where a sale is contemplated in the next two or three years. A recap trades future flexibility for present cash, which is a poor trade when the future has no room in it.
The full treatment sits in the guide: dividend recap refinancing.
Related terms
This page explains a term as it is used in the UK lower-mid-market. It is general information, not advice on any particular facility. Terms vary between lenders and between deals, and the drafting in your own agreement governs.