A Private Debt Crisis

Leveraged buyouts once served as a strategic tool when applied judiciously. However, in recent times, leverage has become the norm rather than the exception. In many instances, debt is not merely part of the strategy—it is the strategy itself. To prevent investors from becoming overly reliant on leverage, it is essential to expose them to alternative financing methods before it’s too late.

The risks of this trend are emerging, and if left unaddressed, the consequences could be severe. Private credit has transitioned from the margins to the core of dealmaking, funding a substantial portion of leveraged buyouts, particularly in the middle market. No longer an alternative to traditional financing, it has become a primary source of capital for sponsor-led transactions.

While I am not an expert in private credit, my team and I have observed a significant shift in the industry. When equity and debt financing are sourced from the same ecosystem, risk becomes more concentrated, even if it remains imperceptible. This arrangement may persist for some time before it unravels. If the concerns raised by critics prove accurate and the current private credit boom encounters difficulties, the resolution will not stem from creating new financial structures to make expensive capital appear more affordable. Instead, it will require a return to value creation that doesn’t predominantly rely on leverage.

It is crucial not to dismiss leverage outright. When employed judiciously, leverage can lower the cost of capital, facilitate acquisitions, and stimulate growth. However, the industry has veered toward an unsustainable point where leverage often functions more as an assumption than a tool. When underlying assumptions change—something inevitable—systems built upon them are tested.

Private equity investors are grappling with a critical question: how much of the past decade’s performance was driven by genuine operational improvement and how much was a result of financial structures enabled by abundant, inexpensive capital? As interest rates have adjusted, this question has become increasingly pressing. Dealmakers and lenders have observed tighter interest coverage, more challenging refinancings, and reduced flexibility in capital structures that once seemed resilient.

Returns that were once taken for granted in a low-interest-rate environment are proving more challenging to achieve.

The rise of debt-heavy private capital is not an isolated phenomenon. It has evolved alongside incentives that prioritize scale, speed, and short-term outcomes. When leverage amplifies success, it appears as innovation. Conversely, when it exacerbates vulnerability, it reveals the extent to which many outcomes are contingent on structure rather than substance.

This explains why private capital without leverage may appear unconventional today, even though it is not a novel concept. Acquiring and holding companies with minimal or no debt demands that investors focus on fundamentals, customers, cash flow, and long-term growth. Without the support of leverage, performance must come from the business itself.

Financial engineering cannot replace execution. In an unlevered model, returns are primarily driven by profits. The pressure to manipulate asset values aggressively or rush toward exits diminishes. Companies are sold when it makes strategic sense, not because of covenant deadlines, refinancing schedules, or fund timelines. Investors can afford patience as cash is no longer allocated to servicing debt.

Sales still occur, but they occur for reasons rooted in the business, such as scale, complexity, or market position, rather than being dictated by leverage.

While it is commonly asserted that debt instills discipline, this is not entirely accurate. Lenders impose scrutiny, and underwriting can serve as an external check. However, discipline does not necessarily emanate solely from leverage. It can also arise from alignment between investors and operators. Unlevered investors must be explicit about how value will be created.

When this process is undertaken seriously, it becomes evident that some deals are not only compatible with an unlevered approach but are better suited for it. Such opportunities often exist outside the traditional leveraged buyout paradigm. Small and medium-sized businesses are a prime example. According to government and industry estimates, they constitute nearly all U.S. companies, employ nearly half of the private sector workforce, and contribute significantly to economic output.

Many of these businesses are founder or family-owned, profitable, and deeply embedded in their communities. Their margins may be modest, but they are consistent and thin enough that they do not attract the attention of traditional leveraged buyout models. Growth occurs gradually, and owners desire a partner who respects their legacy, culture, and long-term vision.

They do not seek an exit strategy; rather, they seek a partner. Patient, unlevered private capital can be particularly effective in this context. When founders and families retain significant ownership and the balance sheet is not encumbered by debt, incentives become aligned. The focus shifts from managing leverage to enhancing operations, investing in people, systems, and products that support sustainable growth.

While risk remains an inherent aspect of investing, it takes on a different form. It is transparent, operational, and tied to real economic outcomes rather than interest-rate fluctuations or refinancing assumptions. The rewards differ as well. Instead of deriving returns primarily from multiple expansion and leverage, gains stem from businesses that foster genuine value creation and sustainable growth.