Private equity and private credit are deeply interconnected, with private equity buyouts serving as the largest source of demand for private credit financing.
The Buyout Financing Structure
When a private equity firm acquires a company, it typically uses a combination of:
Equity (30-40%): Capital from the PE fund
Senior Debt (40-50%): First-lien loans from private credit lenders
Junior Debt (10-20%): Mezzanine or second-lien financing
This leverage amplifies returns for the PE sponsor while providing attractive risk-adjusted returns for lenders.
Why PE Firms Use Private Credit
Certainty of Execution
Private credit lenders provide “certainty of close”—committed financing that won’t evaporate if public markets become volatile. This is crucial in competitive auctions where winning bids require confident financing.
Flexibility
Private lenders offer more flexible terms than syndicated markets:
– Customized covenants
– Negotiated amortization schedules
– Ability to modify terms as business evolves
Relationship-Driven
PE sponsors develop long-term relationships with preferred lenders, creating efficient deal execution and better terms over time.
The Lender’s Perspective
Alignment of Interests
PE sponsors have “skin in the game”—their equity is subordinate to debt, creating incentive to protect lender interests.
Professional Ownership
PE firms bring operational expertise, strategic guidance, and resources to improve portfolio companies, reducing credit risk.
Repeat Business
Strong PE relationships generate consistent deal flow and proprietary opportunities.
Deal Example: Software Company LBO
Purchase Price: $500 million
PE Equity: $175 million (35%)
First-Lien Debt: $250 million (50%)
Second-Lien Debt: $75 million (15%)
First-Lien Terms:
– Interest Rate: SOFR + 5.50%
– Loan-to-Value: 50%
– Financial Covenants: Leverage ratio, interest coverage
– Security: All company assets
The private credit lender earns 9-10% returns with downside protection from equity cushion, covenants, and collateral.
Market Dynamics
Competition and Terms
When private credit capital is abundant, PE firms benefit from:
– Lower interest rates
– Looser covenants (“covenant-lite”)
– Higher leverage multiples
When capital is scarce, lenders command better terms.
Mega Deals
Largest buyouts ($5B+) often require syndicated financing from multiple lenders due to concentration limits.
Risks and Considerations
Overleverage: Aggressive PE deals can leave insufficient equity cushion
Add-On Acquisitions: Bolt-on deals may increase complexity and integration risk
Exit Dependency: Lender returns often depend on successful PE exits through sale or IPO
Future Trends
The PE-private credit partnership continues evolving:
- Direct Lender Equity: Some credit funds now take equity co-investments
- GP-Led Secondaries: Financing PE fund restructurings
- One-Stop Solutions: Single lenders providing entire debt structure
Understanding this relationship is essential for anyone working in private markets, as these two asset classes are fundamentally intertwined.