Scenic Toronto financial district skyline in the city downtown near Yonge and King intersection, Stock Exchange and banking plaza.Elijah-Lovkoff/iStockPhoto / Getty Images
Rachel Wasserman is an entrepreneur-focused business lawyer as well as a research fellow at the Canadian Anti-Monopoly Project and Social Capital Partners.
Dividends have traditionally been used as a mechanism to return profits to shareholders. Dividend recapitalizations, however, have little to do with profits, as the funds are sourced from taking on new debt. The company itself receives no benefit from a dividend recapitalization, only the burden of loan payments, and the economy loses any stimulus the capital may have otherwise provided – all at the expense of enriching investors.
In recent years, there has been an increase in dividend recapitalizations, most notably in the private equity industry; these investors are using cash flow (not just profits) to enrich themselves. This is a worrying trend.
Cash flow is the lifeblood of a business, it’s what a business needs to operate and grow. When overused, dividend recapitalizations can undermine an economy’s long-term growth and productivity. A large proportion of private equity investors in Canada are foreign – mostly American – which means a lot of this cash is not being recirculated in our economy. This does not bode well for Canada.
There is little public information available on dividend recaps, especially in Canada. However, according to Pitchbook, a leading capital markets resource, the U.S. market is expected to have its biggest-ever year for recaps in 2024, surpassing 2021′s all-time annual high of US$76-billion. There is every reason to believe that trends in Canada mirror those of the United States.
Dividend recaps leave companies with less cash available for productive activities such as business operations and capital investments. With less cash available, a company may be forced to slash expenses, lay off employees or declare bankruptcy when faced with unexpected hardship.
There are many cautionary tales about dividend recaps, the most recent being the BioLab chemical factory explosion and its parent company, KIK Consumer Products, which operates in Canada and the United States. KIK is owned by New York-based private equity firm Centerbridge Partners. KIK took on approximately US$2-billion in new debt, and then returned a sizable portion of that cash to Centerbridge and their investors.
KIK is expected to incur US$200-million in interest payments in 2024 alone and will have to use its cash flow over the coming years to pay for a loan that largely benefited Centerbridge and their investors. The economy also misses out on any investment KIK could have made had it not been burdened by these debt payments. Even worse, after the explosion, with KIK already leveraged to the hilt, the thousands of local residents forced to evacuate may find themselves with insufficient recourse against these emaciated companies.
A rising trend of dividend recapitalizations may explain Canada’s lacklustre economy. Canada has a big productivity problem, which is partly because of a lack of business investment. The country’s business R&D investment in 2019 accounted for only 0.79 per cent of GDP, ranking a measly 26th out of 37 OECD countries.
Corporate investment per worker in the country declined 20 per cent between 2015 and 2021. Canadian companies are not investing as much as they used to. Instead of building growth, companies are increasingly choosing to buy it (through M&A) or forsaking growth to distribute capital back to investors.
Shareholder distributions are rising in Canadian public companies. While data on private companies is limited, the following public company statistics can provide an illustration – assuming private equity-owned firms distribute cash in a similar fashion – given their shared goal of maximizing investor returns. From the mid-80s until 2014, Canadian public companies distributed approximately 38 per cent of their profits to shareholders and invested approximately 36 per cent of profits into capital expenditures.
From 2015 to 2022, shareholder distributions increased to approximately 50 per cent of profits, while capital investment fell to less than 20 per cent, and then to 10 per cent in 2020-2022.
Given the opacity of our private markets and limited available information, it’s impossible to know exactly how prevalent dividend recapitalizations are in Canada. But it’s a fact that the practice is rising in the United States, and that Americans are involved in a majority of Canadian private equity deals.
To increase productivity, we need to invest in our businesses, not just cash them out. Policy alone cannot solve the productivity crisis; businesses also need to operate more productively. And we can’t properly discuss improving productivity without addressing unproductive behaviour such as dividend recapitalizations as well as leveraged buyouts and share buybacks.
If we are serious about improving productivity in Canada, we must consider the impact this extractive behaviour is having on our economy, especially when it isn’t even really benefiting that many Canadians.