A buyout gone wrong creates fireworks in the private credit market

A loan payment that has sent shockwaves through the $1.7tn private credit industry is being seen as a test case on whether private equity shops are willing to rupture relationships with lenders to save troubled investments.

Creditors to tech-focused buyout shop Vista Equity Partners were taken aback by the firm’s decision to shuffle assets about one of its software businesses, allowing it to then inject about $50mn to cover a recent interest payment, according to several people briefed on the matter.

The asset shift left private capital firms including Blue Owl and Ares with diminished collateral underlying their loan to Pluralsight, an educational software company purchased by Vista in 2021 for $3.5bn.

Aggressive refinancings that rearrange collateral packages have become the norm in the syndicated bank loan market used to finance mega leveraged buyouts.

But the burgeoning private credit market has been pitched as more collegial, with private equity sponsors perceived to have tighter relationships with a smaller group of lenders. What is more, the documents underpinning the loans have typically had stricter terms, preventing mischief. The Pluralsight conflict is testing that assumption.

One top restructuring lawyer not involved in Pluralsight but watching the fireworks said: “The philosophical premise of private lending (relationship banking) is inconsistent with today’s debt covenant standards, and it’s not surprising at all that a) private lenders took the risk on a market (ie garbage) covenant package, and b) got hurt.”

The difficult negotiations and Vista’s decision to go ahead with the financing manoeuvre known as a drop-down, underscores the troubles a growing number of buyout shops are facing as some of their big bets struggle to live up to expectations before the Federal Reserve started raising interest rates.

The US central bank’s shift in policy has curbed valuations broadly and has made it harder for highly indebted groups to keep up with their debt payments.

Vista had acquired Pluralsight using a “recurring revenue” loan that allowed for high leverage at a time of near-zero interest rates. One person familiar with the company’s recent financial results had said operating cash flow was still not yet high enough to meet its interest costs.

The company, which sells training tools to tech companies, was hit by lay-offs across the industry as well as the uptick in interest rates.

Vista began negotiating with lenders over a deal to restructure its balance sheet earlier this year. But the parties were far apart and in March Vista informed its counterparties that it had hired the investment bank Ducera Partners and brought on its existing lawyers at Kirkland & Ellis to advise it through the talks.

The lenders remain steadfast that they should be repaid in full and that if Pluralsight defaults on its $1.7bn of debts, Vista will need to hand ownership of the company over to the lending group. But hoping to buy some time in talks as the May interest payment approached, Vista moved Pluralsight intellectual property to one of its foreign subsidiaries, where it could raise additional money.

While that did not fully strip the asset away from the lenders, it gave Vista breathing room to continue talks — the new money it put in is secured by the intellectual property and will need to be paid off before the original lenders are paid out.

Some people involved in the deal said they did not understand Vista’s end game, given the loan documents limit the amount of debt it can raise to about $170mn, a figure that includes the new $50mn loan from Vista.

Vista declined to comment.

But the private equity firm, which wrote its investment in Pluralsight down to zero, could still negotiate for warrants or a small portion of the equity in the company if it ultimately turns around. It is a return that could help it recover some of the losses it has tallied on Pluralsight.

“Sponsors will protect that risk because for them it’s a disaster . . . to go from a balance to a zero,” Jarrod Phillips, the chief financial officer of Ares, said at a conference last week. “And that leaves them a large hole to dig out of.”

The provisions in the Pluralsight loan agreement that allowed the drop-down transaction Vista executed are widespread in private credit documents, people involved in the deal said. But they noted that the lenders had also built in their own safeguards: principally the limits on how much debt could ultimately be raised by the subsidiary.

That has curbed the potential fallout. In the syndicated loan market, some aggressive manoeuvres have given way to drawn-out court battles, with Wall Street titans fighting for scraps — often after a company has filed for bankruptcy.

Vista has spent recent days trying to smooth relationships with some of the lenders, with one person involved describing it as “damage control”. Its lenders include a who’s who of the private credit industry: Blue Owl, Ares, Goldman Sachs Asset Management, Oaktree, BlackRock, Golub Capital and Franklin Templeton’s Benefit Street Partners.

“It’s all fun and games when they’re all making money together,” another person involved in the deal said. “But it’s a zero-sum game in every restructuring. That’s creating new sources of tension.”

One lender, who said some creditors were “apoplectic” about the drop-down, nonetheless pointed to their “huge relationship” with Vista. The private equity group has frequently tapped the private credit market to finance its takeovers, including of tax software provider Avalara and insurance software maker Duck Creek Technologies.

“Some deals just don’t work out and when they don’t work out we expect our partners to work with a partnership-like mentality,” they said, adding that lenders expected Vista to “go down the path of a consensual turnover” of the business to their control.

But they cautioned that if the restructuring were to become “adversarial”, it would “have tremendous impacts on the relationship”. They added: “If you look across the universe of large direct lenders, it’s pretty much everybody in here.”

Other industry giants are watching too, keen to see if sponsors will feel liberated to use creative tactics to hold on to their portfolio companies and to see how different parties behave. “The world is watching,” the lender added.

Pluralsight, Vista, Blue Owl, Ares, Goldman, Oaktree, BlackRock, Golub and Benefit Street Partners declined to comment.

For its part, those close to Vista said the transaction was much less aggressive than recent market practices and was well within the flexibility built into the debt contract that Pluralsight negotiated upfront with the lending group.

One hedge fund investor not involved in the Pluralsight situation noted that Vista was not known as a buyout firm that played rough with its creditors. Just last year, Vista had invested $1bn in junior equity, below new creditors, to keep another software investment, Finastra, afloat.

“Vista has had a reputation of standing behind deals and caring about their brand,” this person said.