Private Equity’s Debt Dilemma: Rising Rates and the Surge in Bankruptcies

Over the past year, a spate of private equity (PE) and venture capital (VC) portfolio companies, especially in the US consumer and healthcare sectors, have succumbed to bankruptcy. According to S&P Global Market Intelligence, a record 110 PE/VC-backed firms filed for bankruptcy in 2024 — the highest figure since S&P began tracking the data in 2010. Several high-profile examples, such as ConvergeOne (rebranded as C1) and Instant Brands, illustrate how high leverage, soaring interest rates, and weaker consumer demand can swiftly unsettle carefully structured buyouts.

While this wave of distress is most pronounced in the United States, the broader macroeconomic challenges have been felt globally, including here in the UK, where the Bank of England has raised interest rates from near-zero in late 2021 to around 5.25% by late 2024. In the eurozone, the European Central Bank (ECB) has also increased borrowing costs sharply over the same period. This rising-rate environment erodes interest coverage ratios and places severe pressure on PE-backed firms that rely heavily on floating-rate loans. A period of cheap money allowed sponsors to load up on debt, but servicing that debt has grown more burdensome in the current climate.

Why Are PE-Backed Companies Under Strain?

1. Excessive Leverage

   Many of these bankruptcies can be traced to leveraged buyouts (LBOs) in which the target companies were saddled with substantial debt. The hope was that rapid operational improvements and solid consumer spending would outpace rising interest costs. However, once inflation soared and central banks responded with rate hikes, interest expenses ballooned. As Lawrence Kotler, bankruptcy partner at Duane Morris, put it: “Everything is leveraged to the hilt.”

2. Sluggish Consumer Spending

   Consumer-facing businesses, from Instant Brands’ kitchen appliances to Joann’s fabric stores, have been especially vulnerable to reduced spending power. When shoppers tighten their belts, revenue falls, and over-leveraged companies struggle to generate sufficient cash flow. Although UK households have shown resilience, discretionary spending in both the US and the UK remains under pressure from persistent cost-of-living concerns.

3. Operational Hurdles

   Besides macro headwinds, some firms lacked robust operational strategies post-acquisition. In the ConvergeOne case, their spree of seven acquisitions on top of existing debt was too large a burden when interest rates rose. Meanwhile, Instant Brands became embroiled in lawsuits over dividend recapitalisations that allegedly left the company with insufficient capital to weather disruptions.

Out-of-Court Restructurings on the Rise

Interestingly, FTI Consulting reports that the number of larger PE-related Chapter 11 filings (formal bankruptcies) has not grown as sharply. The reason? A surge in out-of-court deals, frequently referred to as liability management exercises (LMEs). These often involve extending maturities, swapping debt for equity, or negotiating new funding from existing lenders. While these manoeuvres can buy time and potentially avoid the stigma of a court-led reorganisation, AlixPartners found that fewer than half of these exercises proved successful in the long run, with a mere 3% resulting in a permanent fix.

Repeat Bankruptcies and the ‘Chapter 22’ Phenomenon

High leverage and temporary fixes have led some companies into multiple bankruptcy proceedings. Joann, the US-based retailer previously owned by Leonard Green & Partners, emerged from its first Chapter 11 in early 2024 only to re-file months later. Dubbed “Chapter 22” or even “Chapter 33” in extreme cases, this pattern underlines how precarious it can be to address core balance sheet issues with short-term measures.

MY ANALYSIS & OUTLOOK

From my perspective, the present wave of bankruptcies highlights a trifecta of challenges for PE-backed companies: (1) Over-leveraged capital structures, (2) tightened monetary conditions, and (3) inconsistent consumer demand. While I recognise that many sponsors are adept at restructuring and have ample dry powder to support their portfolio companies, the cost of capital has drastically altered the viability of deals that were executed under ultralow interest rates.

In the UK, I foresee a continued divergence between high-performing PE-backed businesses (especially those in non-cyclical sectors like tech-enabled services) and those struggling with legacy debt. With the Bank of England remaining hawkish to combat persistent inflation, interest rates could remain elevated, exerting additional strain on companies heavily reliant on floating-rate financing. For underperforming firms, expect further uptake of out-of-court restructurings or opportunistic distressed-debt purchases by hedge funds eager to capitalise on discounted valuations.

On the bright side, periods of market dislocation can create compelling opportunities for disciplined investors. Distressed asset specialists and secondary market players may find mispriced deals, particularly as forced sellers exit under pressure. Meanwhile, sponsor groups that excel in operational turnarounds could leverage this environment to acquire distressed assets at lower multiples, provided they can stabilise underlying fundamentals.

Conclusion

Private equity’s current predicament — “leveraged to the hilt” in a higher-for-longer rate environment — serves as a stark reminder of cyclical risks inherent in leveraged buyouts. The macroeconomic backdrop has shifted dramatically, exposing the vulnerabilities of over-extended capital structures. Moving forward, rigorous due diligence, conservative capital structures, and agile operational strategies will be critical for both sponsors and LPs navigating this period of heightened financial stress. Although these developments originate largely in the US, the lessons are universal, especially for UK-based stakeholders monitoring the interplay between interest rates, consumer behaviour, and leveraged debt in the months ahead.