Solvency Opinions

Private Equity's Growing Need for Liquidity

As private equity sponsors face growing pressure to return cash to shareholders, dividend recapitalizations have become an increasingly important liquidity tool.

Benjamin Westcott, CFA
Managing Director, Transaction Advisory Services
Marshall & Stevens

Introduction

With traditional exit markets remaining selective and longer holding periods becoming more common, sponsors are increasingly utilizing dividend recaps as a way to provide shareholders with partial liquidity without requiring a full sale or IPO. Independent solvency opinions remain critical in supporting these transactions by providing company stakeholderswith added confidence that the company can remain solvent, pay its costs as they come due, and remain adequately capitalized following the distribution, while also offering the board an additional measure of protection in evaluating and approving the recapitalization.

The Growing Importance of Liquidity

For LPs, unrealized portfolio value and low Distributed to Paid-In Capital (DPI) limit their ability to fund new commitments and rebalance portfolios. As a result, LP evaluation of private equity sponsors is shifting away from IRR to DPI as the key measure of private equity sponsor performance. DPI offers a clearer measure of actual cash the GP has returned to investors, while IRR remains heavily influenced by unrealized portfolio valuations.

Dividend Recaps and the Need for Solvency Opinions

While dividend recapitalizations can be an effective way to unlock liquidity, they also introduce meaningful risk. Added leverage can leave companies more exposed to downturns and may create potential legal exposure for directors and sponsors. If creditors later argue that a recapitalization left the company undercapitalized, they could pursue fraudulent transfer claims in bankruptcy. Directors must therefore be able to show that they carefully considered the company’s solvency at the time of the transaction to help mitigate allegations of fiduciary duty breaches. Lenders also need confidence that the borrower can support the additional debt and continue meeting its obligations.

Solvency Opinions provide independent analysis that a company is expected to remain financially sound following a recapitalization. Solvency Opinions analyze whether the company’s assets will exceed its liabilities, whether projected cash flows are sufficient to service obligations, and whether the company will retain adequate capital to operate after the distribution. Rather than relying on a single projection case, solvency analyses typically evaluate multiple scenarios and stress cases to determine whether the company can withstand adverse conditions. This broader review gives boards defensible support for approving the transaction and provides lenders and other stakeholders with additional confidence.

For boards, lenders, and investors, a solvency opinion is not merely a formality; it is an important safeguard. An independent opinion demonstrates diligence, supports fiduciary decision-making, and reduces the risk of future challenges. In today’s market, solvency opinions help distinguish responsible recapitalizations from transactions that create unnecessary exposure.

Written by Ben Westcott

Ben Westcott is a Managing Director with more than a decade of experience working in financial valuation. He joined Marshall & Stevens in 2024 with the acquisition of ValueScope.