Private equity dividend recapitalizations for technology companies

As valuations have decreased and interest rates and capital costs have increased, private equity groups are rethinking how they can return capital to investors. The valuations of technology companies from 2023 to 2025 have been lower since the peaks in 2021 through 2022. Combined with greater economic uncertainty, this has led to longer holding periods of technology portfolio companies.

Equity and liquidity planning are top of mind for private company leaders, according to a 2025 report on liquidity trends published by Morgan Stanley at Work. Around 80% of survey respondents said they feel pressure to facilitate a liquidity event, and 33% said they feel unprepared to do so.

One way that private equity groups are looking to return capital to investors without selling their investments is through dividend recapitalization. This process involves the portfolio company taking on more debt to finance dividends for its investors.

Key considerations: Tax implications of dividend recapitalization

Private equity groups should consider specific tax implications when deciding whether to go down this path. The first is whether the cash disbursement from recapitalization would be considered a taxable dividend or a nontaxable return of capital. This treatment is determined on the basis of the portfolio company’s earnings and profits in the year of the dividend as well as the cumulative earnings and profits since the company’s inception.

An additional area of concern for technology portfolio companies is the increase in taxable income related to the capitalization of research and development costs under section 174, interest expense limitations under section 163(j), and global intangible low-taxed income (GILTI) inclusions for income generated by controlled foreign corporations. These provisions are set to become more favorable to taxpayers with the passage of the One Big Beautiful Bill Act—but some technology portfolio companies that show historical book losses may have positive earnings and profits for tax purposes. Private equity groups need to determine what these nuances will mean for recapitalization, especially now that the act has modified those key business tax provisions and how they interact.

Another important issue—present before the OBBBA—is that of portfolio companies making add-on acquisitions and the previous owners rolling over their shares. These rollover investors are entitled to cash disbursements—but in some cases have received no cash while still accruing taxable dividends and resulting tax liabilities. Private equity groups need to understand this potential discrepancy, communicate with investors early about possible cash tax dues and potentially set aside cash to reimburse these investors for cash taxes paid.

Action items

Discussing these tax implications with a third-party tax advisor can help limited partnerships and investors be aware of and prepared for any cash taxes as a result of dividend recapitalization.

Some specific areas where a third-party advisor can help include:

• Earnings and profit analysis: Perform an up-to-date earnings and profits analysis to help determine whether a distribution is a taxable dividend or a return of capital.
• Withholding issues: Assess withholding tax issues related to dividends paid to foreign investors.
• Section 704(c) allocations: Analyze any built-in gains related to rollover of property into the new partnership.
• Schedules K-1 and K-3 compliance: Prepare and file the K-1 and K-3 forms that must be provided to investors, reflecting any dividends or return of capital.