Private Credit Playbook: Maximizing Value When Facing a Challenged Outlook
Private credit workout activity is typically difficult to officially track, but based upon Lincoln International’s proprietary data, stress is measurably increasing in the market. Many private equity transactions effectuated during the 2020-2022 period are now approaching debt maturities in an environment characterized by higher financing costs and, in some cases, earnings performance below underwriting expectations. Lender foreclosures are on pace to far exceed prior-year levels, with $25+ billion in foreclosure activity year-to-date. Amendment activity remains elevated as borrowers seek additional runway.
As private equity and private credit lenders alike work through the current cycle, elevated distressed activity is likely to be the new normal. Private credit is experiencing its first meaningful down-cycle as an established source of leveraged buyout financing, requiring sponsors and sophisticated lenders to assess strategic alternatives. This distressed activity is putting greater demands on workout teams and portfolio management capabilities, but it is possible to preserve significant value through alternative strategies.
Summary
- Lincoln International’s capital advisory experts outline the expanded workout playbook for private credit sponsors and lenders in distressed situations.
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In the article below, Lincoln International’s Capital Advisory Group outlines the considerations for sponsors and lenders and the expanded workout playbook in the face of private credit stress. Our team is uniquely positioned to offer insights to both sponsors and lenders amid this private credit down cycle as a market leader in private credit restructurings.
Considerations for Sponsors: Timeliness Is Key, and Cash Is King
How and when strategic alternatives are explored is critical: Earlier intervention provides more time to evaluate capital, liability management and mergers and acquisitions (M&A) solutions. Waiting until a debt maturity is around the corner or liquidity is exhausted dramatically reduces the available playbook. Similarly, distinguishing between liquidity issues, capital structure constraints and overall enterprise value pressure points is important for sponsors at the earliest signs of trouble. In fact, Lincoln is increasingly being consulted earlier by both sponsors and lenders in the face of challenged outlooks to assess strategic alternatives. Optionality declines as distress intensifies, so it is important to begin exploring paths forward as cracks begin to emerge.
Beyond timing, cash remains king. Sponsor capital retains its power to drive outlier results, as infusions continue to meaningfully move the needle. “Dribbling in” capital, while still the norm based on Lincoln’s data, has lost its negotiating leverage. Instead, providing new significant capital to fund a turnaround business plan demonstrates portfolio company support and, in turn, can lead to meaningful lender support and concessions.
In recent months, private credit lenders have taken over more portfolio companies as compared to historical periods. With ownership management capabilities still being built out, private credit lenders (now, turned owners) are experiencing first-hand the challenges and commitment required to steward a business through a phase of transition. This has resulted in two trends: (i) an acknowledgement of the ‘stewardship premium’ historically provided by sponsors and (ii) an increasing requirement to evaluate M&A alternatives alongside standalone restructuring options.
Against a backdrop of increasing stress across private credit portfolios, sponsors with the ability and willingness to contribute meaningful capital may retain significant influence over the outcome. Proactive sponsors may therefore have greater flexibility to pursue value-generating solutions.
Anticipating Lender Behavior: A Sponsor’s Playbook for Challenged Credits
As private credit markets experience increasing stress, lenders are becoming more proactive in evaluating challenged credits and the alternatives available to protect their investments. For private equity sponsors, understanding how lenders assess these situations is critical to preserving negotiating leverage, maintaining control and maximizing value.
Lenders ultimately evaluate challenged situations through the lens of potential recovery, and several considerations increasingly influence how lenders assess these situations:
Enterprise Value and Recovery Expectations
Lenders will evaluate the underlying value of the business relative to outstanding debt, including whether there is sufficient enterprise value to support the existing capital structure. When equity value is impaired, lenders may become less willing to provide concessions without meaningful sponsor support or a credible path to improved performance.
Liquidity and Future Capital Requirements
Beyond near-term liquidity, lenders will assess the amount of additional capital required to stabilize the business and whether the proposed solution provides sufficient runway to execute a turnaround. Repeated requests for incremental liquidity without measurable improvement may undermine confidence in the sponsor’s strategy.
Business Performance and Credibility
Lenders will differentiate between temporary operating challenges and structural business deterioration. The credibility of management’s forecasts, historical performance against projections and the sponsor’s ability to execute an actionable business plan will influence lender willingness to support an amendment or restructuring.
Sponsor Commitment and Alignment
A sponsor’s willingness and ability to contribute meaningful additional capital can materially influence lender behavior. Lenders increasingly evaluate whether sponsors have sufficient economic incentive to support the business and whether the proposed allocation of risk and value appropriately reflects the circumstances.
Alternative Recovery Paths
Lenders will compare the economics and execution risks of continued sponsor ownership against other outcomes, including a sale, consensual restructuring or foreclosure. While lenders generally prefer to avoid owning and operating businesses, they may pursue control when alternative strategies offer superior expected recoveries or when confidence in the existing ownership structure deteriorates.
Implications for Sponsors: Proactively Shaping the Lender’s Assessment
Understanding these considerations allows sponsors to develop strategies that address lender concerns while preserving optionality and negotiating leverage.
Sponsors should approach lender discussions with a well-developed assessment of the business, its capital needs and the relative economics of available alternatives. Demonstrating that continued sponsor ownership represents the most attractive risk-adjusted recovery path can be a powerful negotiating tool.
Successful strategies may include presenting a credible operating plan supported by realistic financial projections, committing meaningful capital alongside lender concessions, identifying opportunities to reduce leverage through asset sales or other transactions and evaluating strategic alternatives before liquidity constraints limit available options.
Equally important, sponsors should proactively assess their rights and flexibility under existing credit documents, including covenant protections, cure provisions, collateral arrangements, voting thresholds and lender remedies. Understanding these dynamics before a liquidity crisis or default can materially improve a sponsor’s ability to negotiate a consensual outcome.
Ultimately, the sponsor’s objective should be to demonstrate that its continued involvement, support and strategic direction offer lenders a better economic outcome than the alternatives. Sponsors that anticipate lender concerns, establish credibility early and develop actionable solutions are better positioned to preserve value and influence direction.
Once sponsors understand how lenders are evaluating a challenged situation, the next step is identifying which strategic alternatives can address lender concerns while preserving the greatest possible value for existing stakeholders. The effectiveness of these strategies depends on timing, capital availability and the relative negotiating positions of the parties.
Regardless of the solution pursued, the sponsor-lender relationship has a material impact on the outcome of a workout. The more transparent and constructive a sponsor has been throughout the process, the more likely a consensual solution can be reached with a lender. Conversely, it is also critical for lenders to maintain credibility with sponsors to the extent that internal institutional headwinds allow. Often, the best relationships (and the best results) are fostered with a smaller group of lenders and fewer required decision makers with seats at the table.
For sponsors and lenders facing a challenged outlook, it is critical to find an advisor who can provide a comprehensive assessment of strategic alternatives, industry perspectives and creative solutions like the ones outlined above.
Looking Ahead with Lincoln International
Amid elevated workout activity in private credit, the balance of power has shifted back to sponsors. The ‘stewardship premium’ and ability to support a business with fresh capital can meaningfully move the needle in this market environment. That said, lenders are increasingly taking proactive action to ensure the preservation of their collateral and associated recovery of capital, as underscored by rising foreclosure activity. Importantly, the toolkit for private credit workouts is broadening and becoming more sophisticated, and it is critical for sponsors and lenders to be fluent across the various playbook dimensions.
Sponsors and lenders who evaluate their options earlier in the workout process have a greater ability to negotiate from a position of leverage and optionality. Reach out to the capital advisory experts below to assess your options when facing a challenged outlook.
