medium · Private Equity paper-lbo
Consider an LBO where a sponsor acquires TargetCo for $600M. The deal is funded with $350M of debt and $250M of sponsor equity.
If the sponsor executes a dividend recapitalization in Year 3 by borrowing an additional $150M to pay a dividend, which of the following is the most likely impact on the fund's performance metrics?
- The IRR decreases because the company's leverage ratio increases substantially post-recap, which makes the overall equity investment far riskier.
- Both the IRR and the MoIC increase significantly, since the sponsor effectively treats the newly borrowed recap debt as 'free' capital at exit.
- The MoIC increases because the sponsor now has less 'skin in the game' at risk for the remainder of the hold period following the recap dividend payout.
- The Internal Rate of Return (IRR) increases due to the earlier return of capital, while the Multiple on Invested Capital (MoIC) may slightly decrease.
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