Private Equity’s Push for 'High-Water' EBITDA: Risks in Leveraged Loan Markets

In recent weeks, private equity (PE) firms have pushed for a controversial change in loan terms, seeking the inclusion of "high-water" EBITDA provisions in leveraged loans. These provisions allow companies to base dividend payments and borrowing capacity on the highest earnings over any 12-month period, even if their financial performance has since worsened. The move has drawn strong criticism from lenders who argue that it heightens risk, as companies could pay out large dividends while facing declining earnings.

Historically, lenders capped how much PE firms could extract from their portfolio companies, based on earnings at the time of the loan. However, high-water EBITDA would allow PE firms to leverage the best period of earnings, regardless of subsequent performance, creating significant potential downside risk for creditors. Major PE firms like KKR and Brookfield have attempted to introduce these terms into loan agreements for high-profile buyouts, such as KKR’s $4.8 billion acquisition of Instructure, but these clauses were eventually removed after lender pushback.

The rationale behind this push is clear: with fewer deals in the pipeline and competition among lenders for quality loans, PE firms are seeking maximum flexibility to deliver higher returns to investors. With dividend recapitalisations—where debt is raised to pay dividends—on the rise, PE firms are looking to take advantage of favourable terms while they can. In fact, the average dividend size in recapitalisations this year has reached £265 million, the highest in six years. MY ANALYSIS

From my perspective, this tactic highlights the growing tension between PE firms’ desire for flexibility and lenders' need for protection. PE firms want the ability to distribute cash to investors even if business conditions deteriorate, but this erodes lender safeguards that were designed to ensure that loans remain sustainable. With leverage ratios rising to an average of 5.1x EBITDA on recapitalisation deals, the risks are clear​.

The rise of private credit also complicates this picture. More PE firms are bypassing traditional syndicated loan markets in favour of private credit, where terms are often more lenient. While this gives PE sponsors greater flexibility, it creates further opacity and risks for the broader market, as private credit deals typically operate with less regulatory scrutiny.

In conclusion, the push for high-water EBITDA reflects a broader shift in the private equity landscape, where sponsors are increasingly willing to test the limits of traditional loan structures to maximise returns. However, lenders are right to be cautious. As economic uncertainty looms and interest rates remain elevated, maintaining robust credit protections will be essential to avoid instability in the leveraged loan market.