AIFM directive to restrict dividend recaps

The opportunities for private equity houses to execute dividend recaps will be restricted next summer as European legislation comes into force.

As the exit climate continues to be impaired, more private equity firms are looking at dividend recaps to return money to investors, according to research by Fitch Ratings. However, under the Alternative Investment Fund Managers Directive (AIFM), private equity firms will be unable to distribute dividends to shareholders in the first two years of owning a controlled entity.

The directive will apply to EU companies but not to small and medium-sized enterprises. It is yet unclear how the various EU member states will interpret the directive, so it is therefore not known what the exact impact will be, legal sources said. 

However, according to Christopher Gardner, an associate at Dechert, the directive will create a two level playing field because these provisions will not apply to managers who are not subject to the directive. “For instance, if you are a non-EU manager with a non-EU fund and are not marketing in the EU, then these rules will not apply – nor will they apply to non-EU target companies.”

As a result of this, private equity firms might take a different approach when acquiring a company, he indicated. “If you are looking at a target company in the EU and one outside the EU – to which these rules don’t apply – and all other things are equal, then in the absence of asset stripping rules affecting the non-EU target company and if the ability to carry out a quick dividend recap is a key returns driver, then the non-EU target company would appear more attractive from this perspective,” said Gardner.  

In addition, if a dividend distribution is not an option in the first two years, firms will be looking out for consolidation, Thierry Monjauze, a managing director at Harris Williams, said. “Firms will need to think ahead of time more than normal in terms of what the M&A opportunities are within a given sector as consolidation is likely to play a larger role,” he said, adding that restrictions on dividend recaps “are likely to impact returns”.

However, a typical private equity firm is likely to focus on other portfolio company issues, rather than distributing dividends in the first two years of ownership. “It is important to remember that private equity firms usually acquire companies with a view to holding them for two to five years and then selling them,” Simon Witney, a partner at SJ Berwin said. “These restrictions do not seek to interfere with that business model,” he added.

While dividend recaps are increasing, the scale of the practise is a lot smaller than it used to be. Global financial sponsor-related loan volume for the purpose of dividend recaps has reached $18.1 billion so far this year, compared to $72.1 billion in the same period in 2007, according to data provider Dealogic. The lending climate in Europe continues to be much more challenging than in the US, Gardner said. “I suspect that dividend recaps are not being done to anywhere near pre-crisis levels, because there simply is not the level of debt available to support dividend recaps.” 
 
Regardless of the exact impact of the AIFM directive, it is important for private equity firms to factor this restriction into their deal structures and their planning, Witney said. “Firms need to be aware of these rules as they will be an important consideration for them when they do transactions,” he said.