James Diver
External Managing Editor, Delaware Journal of Corporate Law, Volume 50
Private Equity in a Nutshell
Private equity (“PE”) refers to a type of investment fund that buys, manages, and sells companies to generate returns for their investors. These funds are typically structured as limited partnerships and normally invest in private companies. PE firms use a combination of (1) investor capital; and (2) borrowed money (leverage) to acquire businesses, improve their operations, and later exit—through a sale, initial public offering (“IPO”), or recapitalization.[1] The goal is, and always will be, to create value for investors and deliver higher returns than other investment vehicles.
Over the last few decades, the PE market has expanded at a rapid pace.[2] Low interest rates, innovation in fundraising methods, and alternative exit strategies all played a crucial role in driving PE growth to where it is today. However, over the last couple of years, PE has experienced a noticeable slow down—primarily due to economic uncertainties and market dynamics.[3] Specifically, funds are suffering from: (1) the Federal Reserve’s cautious stance on interest rates and regulation; and (2) difficulties in finding profitable exit strategies from investments made in years prior.[4] Still, cautious optimism exists among PE executives that 2025 will bring back a robust dealmaking market, sparking potential growth in the industry and returning to high levels of investment activity across diverse sectors.[5]
Interest Rates and How They Impact PE
As mentioned above, PE relies heavily on the use of borrowed money to facilitate its transactions. Specifically, they use a leveraged buyout (“LBO”), where the PE firm acquires a company utilizing a significant amount of borrowed money (debt) to finance the purchase.[6] This is where interest rates come in. When rates rise, the cost of borrowing (debt) also rises, meaning it becomes more expensive to finance an acquisition through an LBO.[7] In simpler terms, higher rates (generally) stifle growth in PE markets.
After the 2008 Financial Crisis, rates fell to near-zero levels in order to make borrowing cheaper, as well as encouraging businesses to spend.[8] The PE industry took advantage of this—LBO activity boomed, there was a surge in volume of deals being made, and firms could pursue more acquisition options.[9] However, this period of development would eventually end when the COVID-19 pandemic hit, which led to U.S. inflation reaching its highest levels in June 2022.[10] To combat inflation, the Federal Reserve raised rates to record highs, dramatically impacting PE markets. Although rates have come down in the last two years, they are still elevated compared to the pre-pandemic environment, and PE markets have not yet fully rebounded.[11] It is unclear what rates will look like in 2025. As of one month ago, the Federal Reserve announced an interest rate hold, maintaining the federal funds rate at its current level.[12] Many experts believe these rates will hold for the foreseeable future.[13]
Problems Getting Out
Along with high rates, limited exit strategies for PE firms are detrimentally impacting the current market. An exit strategy refers to the plan or method by which a firm realizes a return on its investment. In simpler terms, it’s how the firm intends to sell or exit the business it has invested in to generate a profit and return capital to its investors.[14] Examples of exit strategies include: IPOs, trade sales, and secondary buyouts.[15] When exit strategies are restricted, firms risk being locked into the investment for longer than expected and are forced to sell at inopportune times for diminished returns.[16] Thus, having a viable exit strategy is essential to a PE deal—it is a key component that determines whether an investment will be profitable or not.
As of late, sluggish mergers and acquisitions (“M&A”) activity and uncertainty in IPO markets have severely capped exit strategies for PE firms.[17] Increasing regulatory oversight and geopolitical strife has made investors more cautious and chilled their willingness to enter into these markets.[18] Experts are cautiously optimistic that 2025 will see some sort of rebound in both areas, but warn that the pace of recovery will depend on various factors (such as interest rates and potential policy changes under the new U.S. administration).[19]
Solutions Found in Chapter 11
It seems clear to me that the market as a whole has caught up with PE. Rates are high, dealmaking is cold, and exit strategies are constrained. So where does PE go from here? Well, at least in the short-term, I would argue that firms should look to Chapter 11 bankruptcies.
PE-backed bankruptcies provide an opportunity to acquire financially distressed companies at a discounted price. Unlike traditional LBOs, which rely heavily on debt financing and are highly sensitive to interest rate fluctuations, bankruptcy acquisitions benefit from structural advantages that make them less rate-dependent. Firms can leverage debtor-in-possession (“DIP”) financing, which often comes with super-priority creditor status, making it much easier to secure capital in a high-rate environment.[20] Additionally, firms can use credit bidding to acquire assets without deploying fresh cash.[21] They can also facilitate a debt-to-equity swap to gain control of a company without taking on additional leverage.[22] These mechanisms allow firms to execute distressed acquisitions while mitigating the impact of high borrowing costs in a current 2025 environment where rates are elevated.
In addition to being less sensitive to rates, PE-backed bankruptcies also offer clearer and more controlled exit strategies compared to traditional deals. In a bankruptcy setting, firms can structure exits through strategic asset sales (via Section 363), which provide a court-approved, expedited process that minimizes market volatility risks.[23] Additionally, firms can employ a pre-packaged bankruptcy that streamlines the restructuring process and allows for a faster and more predictable exit.[24] This ensures that firms will never be locked into an investment for longer than anticipated.
Therefore, with no foreseeable rate changes on the horizon, as well as slow dealmaking markets, Chapter 11 poses a unique and valuable alternative for PE firms to deploy capital efficiently, acquire distressed assets at a discount, and implement restructuring strategies that create long-term value for their investors. By utilizing the court-approved procedures of Chapter 11, firms can bypass the challenges of traditional LBOs while securing cleaner exit opportunities. This approach will mitigate the impact of high borrowing costs in the short-term and capitalize on future market recoveries with stronger investment opportunities.
About the Author
James Diver is a current third-year law student at Widener University Delaware Law School and is the External Managing Editor for Volume 50 of the Delaware Journal of Corporate Law. Prior to attending law school, James worked as a paralegal for Kimmel & Silverman P.C., a firm that specializes in Lemon Law claims against auto manufacturers. He earned his B.A. in Economics from Union College.
[1] Private Equity Funds, Investor.gov, https://www.investor.gov/introduction-investing/investing-basics/investment-products/private-investment-funds/private-equity (last visited Feb. 28, 2025).
[2] Joe Camberato, Why is Private Equity Gaining Popularity?, Forbes (May 9, 2024, 7:30 AM), https://www.forbes.com/councils/forbesfinancecouncil/2024/05/09/why-is-private-equity-gaining-popularity/ (PE firms now manage roughly 20% of all U.S. businesses).
[3] Allison McNeely & Laura Benitez, Private Equity Faces Pockets of Distress for Long-Held Assets, WealthManagement (Jan. 16, 2025), https://www.wealthmanagement.com/alternative-investments/private-equity-faces-pockets-of-distress-for-long-held-assets?.
[4] Miriam Gottfried, The New Survival Guide for Private Equity: Go Big or Get Back to Basics, Wall St. J. (Feb. 16, 2025, 5:30 AM), https://www.wsj.com/finance/investing/private-equity-fundraising-struggles-408bfe14.
[5] Maria Armental, Private Equity Sees Deal Pipelines Filling in as Year Begins, Wall St. J. (Feb. 21, 2025, 6:00 AM), https://www.wsj.com/articles/private-equity-sees-deal-pipelines-filling-in-as-year-begins-8926ef71.
[6] James McNeill Stancill, LBOs for Smaller Companies, Harv. Bus. Rev. (Jan. 1988), https://hbr.org/1988/01/lbos-for-smaller-companies.
[7] William Craig & Mark Watson, No More Free Lunch: Impact of Interest Rates on Private Equity, Wellington Mgmt. (Feb. 2025), https://www.wellington.com/en/insights/impact-of-higher-interest-rates-on-private-equity.
[8] Id.
[9] Id.
[10] Id.
[11] Taylor Tepper, Federal Funds Rate History 1990 to 2025, Forbes, https://www.forbes.com/advisor/investing/fed-funds-rate-history/ (last updated Jan. 29, 2025, 3:11 PM).
[12] Sabrina Karl, Here’s What Markets Now Predict for 2025 Fed Rate Cuts—and What it Could Mean for Mortgage Rates, Investopedia (Feb. 26, 2025), https://www.investopedia.com/heres-what-markets-now-predict-for-2025-fed-rate-cuts-and-what-it-could-mean-for-mortgage-rates-11686953.
[13] Id.
[14] The Private Equity Exit: Top Exit Strategies and the Biggest Exits of This Year, Allvue (Oct. 5, 2023), https://www.allvuesystems.com/resources/private-equity-exit/.
[15] Id.
[16] Mark Henricks & Arturo Conde, 6 Exit Strategies for Private Equity Investors, SmartAsset (Aug. 20, 2024), https://smartasset.com/investing/exit-strategies-for-private-equity.
[17] Jim Dobbs, Why Bank M&A is Off to a Sluggish Start in 2025, Am. Banker (Feb. 20, 2025, 6:00 AM), https://www.americanbanker.com/news/why-bank-m-a-is-off-to-a-sluggish-start-in-2025.
[18] Id.
[19] Ryan Deffenbaugh, IPO Market Slump Drags on as Unicorns Multiply. Why There’s Hope for More IPOs in 2025., Inv.’s Bus. Daily (Feb. 28, 2025, 12:00 PM), https://www.investors.com/news/technology/ipo-market-slump-unicorns-new-ipo-stocks-2025/.
[20] Julian S.H. Chung & Gary L. Kaplan, An Overview of Debtor in Possession Financing, Fried Frank LLP (2020), https://www.friedfrank.com/uploads/siteFiles/Publications/An%20Overview%20of%20Debtor%20Possession%20Financing.pdf.
[21] Id.
[22] Id.
[23] 363 Sale, Corp. Fin. Inst., https://corporatefinanceinstitute.com/resources/valuation/363-sale/ (last visited Feb. 28, 2025).
[24] Id.
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