What happens to the private equity firm's equity investment after a dividend recap?

• A. Equity increases
• B. Equity unchanged
• C. Equity decreases
• D. Equity doubles

Answer: (C)

Dividend recapitalization uses new debt to pay a large cash dividend to shareholders, including the private equity sponsor. This changes the capital structure by increasing debt while cash leaves the company. If the enterprise value stays roughly the same in the moment of the recap, the equity value drops because equity = enterprise value minus debt. So the amount of value left for equity holders shrinks, even though the sponsor receives a substantial cash payout up front. For example, with enterprise value of 100, debt of 40, equity around 60, a new debt increase to 60 financed by a 20 dividend reduces equity to about 40 (assuming EV stays near 100). The sponsor takes 20 in cash, but the remaining stake is worth less. That’s why the equity investment tends to decrease after a dividend recap.