By Hannah Smith, Francesco Pittatore and Edward Ramirez
Introduction
Private equity has long been defined by its ability to adapt, evolving through cycles of growth, recession, and recovery. However, today’s high-interest rate environment presents a more structural challenge to the industry’s traditional model. What began as a response to monetary tightening has now triggered a re-evaluation of how private equity generates value. With leverage-driven returns being harder to achieve, firms are shifting towards distressed investing, operational turnarounds, and creative capital structuring. This paper explores how this shift is unfolding – examining the macroeconomic pressures, the strategic responses by leading PE firms, and how recent deals reflect this ongoing change.
Rethinking Returns: how Private Equity is Adapting to a High-interest Rate Era
The era of near-zero interest rates allowed many companies to grow by taking on cheap debt, which greatly benefited the private equity (PE) industry. For over a decade, PE thrived on highly leveraged and growth-oriented strategies. However, the current environment – marked by persistently high interest rates (“higher for longer”)—is” putting significant pressure on these same companies and reshaping traditional PE models.
Over-leveraged firms are now facing much higher refinancing costs, directly affecting their margins and overall profitability. Many are struggling to meet financial obligations, leading to covenant breaches and worsening liquidity. Capital-intensive sectors like retail, commercial real estate, and healthcare are among the hardest hit.
At the same time, corporate valuations are decreasing. Higher interest rates raise discount rates applied to future cash flows, reducing the present value of businesses. This, along with rising market risk, has pushed down valuation multiples like EV/EBITDA, making traditional PE deals less attractive while opening new doors for distressed investing.
In response, PE firms are shifting strategies. Rather than focusing on leverage and growth, they are targeting distressed or undervalued companies. Major players like Apollo, Oaktree, and KKR are deploying capital through credit and special situations funds, using tools such as debt-to-equity swaps, DIP financing, and acquisitions through restructuring processes.
Although rising interest rates may be partially cyclical, the shift in private equity strategy appears structural. The “higher for longer” environment is not just a temporary challenge but a systematic transformation. PE firms must now navigate a more complex market landscape, where intrinsic value and disciplined execution drive sustainable performance.
Redefining Alpha: the Strategic Pivot From Leverage to Operational Value
This recalibration raises a broader question: is private equity simply adapting to a cyclical shift in monetary policy, or are we seeing a realignment in how private equity creates value? While there is debate around the longevity of the current macro environment, the immediate impact has already forced firms to move away from the aggressive high-leverage growth playbook.
Instead, there is a growing emphasis on operational value creation and turnaround expertise. Steve Klinsky, CEO of New Mountain Capital, has highlighted this shift – arguing that generating returns through operational improvements, rather than extreme leverage, is not only more suitable but also better suited to today’s credit-constrained market. In distressed and restructuring-focused strategies, this means tighter engagement with portfolio companies and a renewed focus on real EBITDA growth.
Even if interest rate pressures eventually ease, structural headwinds like geopolitical tension, regulatory scrutiny, and political uncertainty could limit a return to previous strategies. Therefore, today’s environment may leave a lasting imprint on the way GPs deploy capital – prioritise resilience, operational control, and downside protection over traditional capital structuring tactics. This shift could ultimately redefine what it means to generate alpha in private equity.
Deal by Deal: how Private Equity is Capitalising on Distress and Operational Challenges
The shift in PE firms’ strategy towards distressed and undervalued assets is already seen in recent major deals. High interest rates and tightening liquidity have allowed PE to step into situations where traditional capital has pulled back, often through restructurings and acquisitions. Two notable recent transactions are Apollo’s involvement in Hertz’s bankruptcy exit and Sycamore Partners’ acquisition of Walgreens Boots Alliance.
In May 2020, Hertz, the car rental company, was forced to file for bankruptcy due to the dramatic decline in travel demand during the height of the Covid-19 pandemic, combined with failed talks with creditors. Apollo, Knighthead, and Certares successfully bid to provide equity capital for Hertz, valuing Hertz at $6.2 billion, according to reports. The recapitalisation included $2.78 billion in common equity investments, $1.5 billion in new preferred stock issued to Apollo, and a $1.64 billion rights offering to existing shareholders. In one of the few instances during in-court restructuring (RX), Hertz attempted to issue new equity under Chapter 11 bankruptcy protection, driven by unexpected demand from retail investors who continued buying Hertz stock despite them being in major distress. Significantly, equity holders therefore received meaningful recovery of up to $8 per share which is very rare in distressed or RX scenarios, making it an interesting example of a solvent debtor case. In bankruptcy proceedings, equity holders typically lose their entire investment.
The plan also included a $239 million cash injection, long-term warrants, and the elimination of 79% of Hertz’s corporate debt. Significantly, the transaction reflects a growing trend in PE, where leveraging capital structure solutions, rather than traditional buyouts, is becoming the preferred entry strategy.
Additionally, Sycamore Partners’ acquisition of Walgreens Boots Alliance (WBA) represents a different strategy in the playbook – one which is focused on operational turnaround rather than a formal bankruptcy process. In a $23.7 billion deal in March 2025, Sycamore privatised the retail healthcare group, backed by fully committed financing. While WBA has not formally entered a restructuring process, the deal highlights its financial challenges, particularly its significant debt load and operational issues, in a capital-intensive sector that’s facing increasing market pressures.
Following the acquisition, a Divested Assets Committee was established to explore ways to enhance operational performance and strengthen the businesses’ balance sheets ahead of any future monetisation transactions. With a strong track record in retail turnarounds, Sycamore is well-positioned to drive value by enhancing operational performance and strengthening the businesses’ balance sheets. Importantly, Sycamore’s acquisition of Walgreens highlights how PE is increasingly helping sectors facing significant operational challenges and financial distress.
The New Reality: Private Equity’s Future Hinges on Execution Over-leverage
Private equity is going through a major shift. With cheap debt no longer available, the old model of using high leverage to drive returns is becoming increasingly difficult. As a result, firms are focusing more on distressed opportunities, operational improvements, and protection against downside risk. There is noticeably increased care in where they invest and how they add value. Even if interest rates eventually come down, this environment has already changed how PE works. In the future, success will rely less on financial engineering and more on solid execution and adapting to tougher conditions.
Bibliography
Dealflower
Mergers&Inquisitions, https://mergersandinquisitions.com/distressed-private-equity/
Bloomberg, https://www.bloomberg.com/news/articles/2025-01-16/private-equity-faces-pockets-of-distress-for-long-held-assets
Reuters, https://www.reuters.com/article/business/hertz-picks-knighthead-certares-and-apollo-to-fund-bankruptcy-exit-idUSKBN2CT1Q6/
Walgreens Boots Alliance, https://www.walgreensbootsalliance.com/news-media/press-releases/2025/wba-definitive-agreement-acquired-by-sycamore-partners
Financial Times, https://www.ft.com/content/722dfbf1-82a1-435d-9f6f-8586c4f0f038
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