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Private equity funds increase exposure to distressed assets

Private equity funds increase exposure to distressed assets

05/30/2025
Giovanni Medeiros
Private equity funds increase exposure to distressed assets

In an era defined by economic headwinds and tightening credit markets, private equity (PE) firms are embracing distressed assets with unprecedented vigor. This shift is not merely a response to external pressures; it reflects a strategic pursuit of value creation and long-term growth. As financial distress becomes more prevalent, the adept use of specialized strategies can unlock opportunities that once seemed out of reach.

Macroeconomic Drivers Behind Distress

The current financial landscape is shaped by rising interest rates and tighter lending practices worldwide. Since early 2022, benchmark rates have climbed over 450 basis points, driving up debt-servicing costs for leveraged companies and straining balance sheets. Concurrently, lenders have adopted more conservative underwriting standards, reducing access to traditional credit facilities and amplifying stress on mid-market and smaller enterprises.

Despite historically moderate corporate default rates of 2–3%, the scale of outstanding debt has propelled distressed-debt exchanges to record highs. Companies across sectors—from manufacturing to retail—are feeling the pinch, creating a growing pool of undervalued assets ripe for acquisition and turnaround.

Why Distressed Assets Are Attractive to Private Equity

For PE investors, distressed opportunities offer unique advantages:

  • Discounted valuations and significant turnaround potential: Acquisitions at lower multiples enable outsized returns once operational improvements take hold.
  • Control through debt-for-equity strategies: By acquiring debt positions, funds can influence restructurings and secure equity stakes at deep discounts.
  • Bolt-on synergies in fragmented sectors: Integrating distressed targets into existing platforms accelerates scale, reduces costs, and enhances market share.

These factors combine to create an environment where nimble PE teams can deploy capital, restructure operations, and drive sustainable growth in companies once deemed too risky.

Key Investment Strategies and Deal Structures

PE firms employ a variety of deal structures to capture distressed opportunities, each tailored to specific risk-return profiles and time horizons. A comprehensive overview of the most prevalent approaches is shown below:

Each approach carries its own advantages and challenges. For instance, out-of-court and ABC transactions often close faster and involve fewer stakeholder complications, while 363 sales deliver stronger legal safeguards for buyers.

Specialized Skills and Fund Structures

Distressed investing demands a broader skill set than traditional PE transactions. Leading firms combine financial acumen with deep operational and legal expertise:

  • Understanding bankruptcy codes, capital structure intricacies and creditor priorities
  • Negotiation tactics with lenders and key stakeholders during restructuring talks
  • Operational expertise to implement restructuring plans and stabilize performance

To facilitate these complex deals, many PE managers have launched parallel or hybrid funds that permit both equity and credit investments. These vehicles mirror certain hedge fund strategies, granting greater flexibility to deploy capital across debt, equity, and structured instruments.

Collaboration between PE partners and restructuring consultants has also intensified, particularly around alternative insolvency processes like ABCs that preserve company value while minimizing reputational harm and legal costs.

Data and Quantitative Insights

The quantitative backdrop underscores the scale of opportunity in the distressed arena. Investors are sitting on record levels of unspent capital, with over $2 trillion in dry powder poised for deployment in 2025. Much of this capital is earmarked for credit and distressed strategies, reflecting both anticipated deal flow and the search for higher yields in a low-growth environment.

Meanwhile, distressed-debt exchange volumes have soared alongside overall debt issuance, even as default rates remain relatively subdued. The global credit market now encompasses $20 trillion in assets, of which roughly $500 billion are in asset-backed vehicles and $1.5 trillion reside in private credit funds. This imbalance points to significant room for growth in the distressed segment as investors seek a balanced portfolio of income and upside.

Regulatory Environment and Outlook for 2025

Heightened regulatory scrutiny of formal bankruptcy proceedings has nudged PE firms toward quicker, less public alternatives. In many jurisdictions, rising administrative costs and protracted court timelines make out-of-court sales and ABCs increasingly attractive.

Looking ahead to 2025, the distressed asset cycle is likely to persist, driven by two potential scenarios:

  • Prolonged high rates could trigger further distress among heavily leveraged companies.
  • Even if interest rates ease, structural debt imbalances may continue to weigh on vulnerable sectors.
  • Private credit and PE managers will maintain a strong focus on vast opportunity in distressed asset strategies, blending direct lending, opportunistic credit, and equity plays.

In this evolving landscape, success will hinge on foresight, agility, and a deep toolkit of restructuring capabilities. For private equity firms prepared to embrace complexity, the rewards can be transformative—for investors, portfolio companies, and the broader economy alike.

As markets recalibrate and new opportunities emerge, one truth remains clear: the most forward-looking PE firms are those that view financial distress not as a deterrent, but as a gateway to lasting value creation.

Giovanni Medeiros

About the Author: Giovanni Medeiros

Giovanni Medeiros