Your market cap is not a piggy bank

Last week, I found a $20 bill on the subway platform.

After looking around to see if anyone dropped it—and not seeing anyone that did—I picked it up, continued my trip to the Noetica office, and used it to buy 4 random people on line at the office cafeteria a cup of coffee.

The point? It’s generally easier to part with cash you didn’t anticipate you’d have. That’s what’s behind “𝗘𝗾𝘂𝗶𝘁𝘆 𝗣𝗿𝗼𝗰𝗲𝗲𝗱𝘀 𝗗𝗶𝘃𝗶𝗱𝗲𝗻𝗱 𝗕𝗮𝘀𝗸𝗲𝘁𝘀” in credit deals.

“𝗘𝗾𝘂𝗶𝘁𝘆 𝗣𝗿𝗼𝗰𝗲𝗲𝗱𝘀 𝗗𝗶𝘃𝗶𝗱𝗲𝗻𝗱𝘀” are payments to shareholders that are permitted to be made under a credit agreement from the proceeds of equity sales. Lenders are normally deeply concerned about cash leaving a borrower—especially if it’s not being used to improve the business and bring in more cash to pay them back. But, from a lender’s perspective, equity proceeds are kind of like finding a $20 bill on the subway floor—lenders weren’t counting on that cash flow for their payments and so they’re routinely willing to part with the “new found cash.”

However, equity-based dividend baskets have started to stray from their initial intentions: credit deals these days have begun to include terms that permit dividend payments based solely on an annual market capitalization percentage. Typically set at 6% - 7% of the market cap of the borrower, these “𝗠𝗮𝗿𝗸𝗲𝘁-𝗖𝗮𝗽 𝗗𝗶𝘃𝗶𝗱𝗲𝗻𝗱𝘀” can usually be paid out 𝙚𝙫𝙚𝙧𝙮 𝙮𝙚𝙖𝙧, don’t require any actual sale of stock and don’t come with a corresponding influx of cash.

In the current credit cycle, these terms have remained relatively rare, but trends show an increase. In Q3 ‘24, only 4% of publicly filed high yield credit agreements included Market-Cap Dividend Baskets and no deals included such terms in Q3 ’23.

Message me if you’d like access to the excel with deal data on Market-Cap Dividend terms.