Could someone who perhaps understands this better than I explain to me the purpose behind a dividend recap? They seem to be very popular among PE firms - where they purchase unlevered, private companies, lever them up, and then essentially distribute out all that cash. I don't quite understand the point of this. Sure, you get a portion of your initial invested capital back, but it can't be tax efficient (and I can't imagine after tax returns look all that enticing?), and you're leaving the company in a much worse situation as well as worth much less than when you found it.
I ask because of a personal situation. I have a family member who works for a private insurance brokerage that is owned by a PE firm. The brokerage is essentially a roll up, massively levering up to go after small brokerages at low multiples. When the initial PE firm bought out the private company, it was unlevered. They then did a dividend recap, and continued to lever up to pursue a rollup. At this point, the company is levered around 5-6x EBITDA, with a lot of noise in the EBITDA/adjusted EBITDA numbers they present due to the huge amount of acquisitions they perform every year.
This next part is what confuses me. Earlier this year, the initial PE firm sold their stake to another PE firm. This new PE firm intends to perform ANOTHER dividend recap with the already massive amount of leverage. I could probably wrap my head around this at a private company in an industry with highly predictable cash flows. And an insurance brokerage has pretty predictable cash flows... but when you're performing a rollup, buying out small, private mom and pop shops where the only thing you're buying is their book/relationships and they no longer have any incentive to perform for you, that scares the shit out of me.
I guess I went off on a bit of a tangent there... but can anyone explain the point of dividend recaps to me? I don't understand how they produce positive results for anyone involved (excluding the banks that is...).