For years, as private credit exploded into a $1.7 trillion industry, the line from the market's biggest players was that their deals were, simply put, safer.
And they were certainly safer than the high-yield bond market, and also safer than the leveraged loan market, where struggling companies could take advantage of weak investor safeguards and team up with hedge funds to aggressively restructure their debt at the expense of existing creditors.
That may still be the case. Deal documents are generally tighter in private credit; loans are financed by smaller "clubs" of lenders with deeper connections to companies and their private equity owners; creditors typically hold the debt to maturity. It all works to mitigate risk for investors, industry advocates say.
And yet, private credit is now having a taste of what happens when things turn ugly.
In recent weeks a Vista Equity Partners-backed tech learning system shifted assets away from its lenders as part of a move to raise $50 million of fresh financing, according to people with knowledge of the situation. For many on Wall Street, the fact that private credit isn't immune to such maneuvers has been eye-opening.
It's occurring as higher interest rates are making it more difficult for many companies to service their debt. All the while, lenders flush with cash and dealing with limited investment opportunities are undercutting each other on pricing and offering unusually borrower-friendly terms as they try to put money to work.
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Some warn it's laying the groundwork for further pain down the road. Just last week JPMorgan Chase Chief Executive Officer Jamie Dimon said that he expects problems to emerge in private credit, and warned that "there could be hell to pay."
One of the biggest selling points of private credit has been the idea that lenders aren't providing the same kind of fast and loose loans that Wall Street banks have been involved in over the years. And yet they're now running into similar problems that have battered leveraged loan investors.
Vista bought Pluralsight, a technology workforce development company, in 2021 for about $3.5 billion. The leveraged buyout was supported by over $1 billion of debt financing by direct lenders.
In the years since, borrowing costs have soared, pushing the rate on the company's debt well into the double digits. Vista recently wrote off the entire equity value of the investment, the people familiar with the situation said.
In an effort to make a $50 million interest payment coming due, the company moved intellectual property into a new subsidiary and used those assets to obtain additional financing from Vista, the people said. The new loan weakens existing lenders' claims against the IP, they added.
Representatives for lenders to Pluralsight including Blue Owl Capital, Ares Management, Oaktree Capital Management and BlackRock declined to comment, and Goldman Sachs Asset Management, Golub Capital and Benefit Street Partners didn't respond to requests for comment. Vista declined to comment, and a spokesperson for Pluralsight didn't respond to requests for comment.
The move is reminiscent of one of the earliest and most notorious examples of collateral stripping: the case of J. Crew Group. The company used loopholes in credit documents that allowed it to transfer intellectual property away from existing lenders to secure new financing. Other struggling companies owned by private equity funds — including Neiman Marcus, Petsmart and Envision Healthcare — have used similar asset moves in recent years to restructure their debt and stave off bankruptcy.
Yet there are big differences between Vista's maneuver and the other deals.
For one, the IP was put into a restricted subsidiary, which is still tied to the covenants of the original loan, the people said. In the most aggressive liability management exercises, the assets are normally dropped into an unrestricted subsidiary, which is not subject to those restrictions and is entirely out of the reach of existing creditors.
Vista also didn't attempt to pit creditors against each other through a distressed-debt exchange, a tactic that unrestricted subsidiaries have been used to support in the past. Still, some lenders have engaged Centerview Partners and Davis Polk & Wardwell for advice on the situation, while Pluralsight is getting advice from law firm Kirkland & Ellis and Ducera Partners, the people said.
Centerview declined to comment, while representatives for Davis Polk, Kirkland & Ellis and Ducera didn't respond to requests seeking comment.
Further debt negotiations between the company and lenders are underway, the people added.
"Some sponsors will be more reluctant than others to do this, but if it avoids a bankruptcy filing or in-court solution, it's something to consider," said Nick Caro, a partner at Goodwin's business law department and a member of the private equity and debt finance groups.
Industry observers expressed concern Vista could shift additional intellectual property away from lenders down the line.
More broadly, amid worries of further stress in private credit, Vista's move sets a dangerous precedent, said Sheel Patel, a partner in the private credit and special situations group at King & Spalding.
The firm could have injected more cash into Pluralsight using an equity investment. Instead, it chose to do so in exchange for a claim on some of the company's most valuable assets.
"People are going to look at this and say, 'Why would I put in equity dollars when I could put in senior debt dollars and juice up my recovery?'" Patel said. "You're going to see more and more sponsors solving portfolio company liquidity issues this way instead of utilizing equity injections or junior capital."
Despite it all, few see a wave of controversial debt transactions sweeping the private credit landscape anytime soon.
Market participants say that governing documents in private credit are still, by-and-large, more protective of lender interests than those in the public markets.
"I don't think that this is the beginning of a proliferation of lender on lender violence in private credit," said Joseph Weissglass, a managing director at Configure Partners. "That said, there is increased probability as private credit capital structures get bigger and collateral and organizational structures more complex."
Others say more money chasing after limited deal supply will inevitably lead to outcomes mired in controversy.
"We have seen some financing deals in private markets involving riskier capital structures that would have probably struggled to get done in public markets," said Sachin Khajuria, who runs the family office firm Achilles Management and invests across private assets. "Because they are private, if issues do arise they may not be as visible until it's too late."
— With assistance from Paula Seligson and Reshmi Basu.
