Distressed Debt & Special Situations

Distressed debt and special situations investing represent some of the most complex and high-conviction strategies within private credit. These approaches involve deploying capital to companies facing acute financial or operational distress, or to those undergoing significant structural change, whether through legal restructuring, ownership transition, or macro-driven dislocation. Unlike traditional credit investing, which focuses on stable income streams and preservation of principal, distressed strategies aim to unlock idiosyncratic value through event-driven catalysts, deep restructuring insight, and active creditor influence.

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Distressed-for-control investing, for example, involves purchasing deeply discounted debt, often in secondary markets, with the intention of gaining influence over the company’s restructuring process. By acquiring sufficient debt, investors can position themselves to drive negotiations, influence reorganisation plans, or convert debt into equity post-bankruptcy. Alternatively, rescue financing or debtor-in-possession (DIP) lending involves injecting capital into struggling companies at a premium, often with priority repayment status and equity-linked upside. Special situation investments may also include litigation finance, regulatory arbitrage, or capital provision in carve-outs, spin-offs, or corporate break-ups.

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The risk-return profile in distressed strategies is highly asymmetric. IRRs can exceed 20–25% in successful scenarios, but downside risk includes prolonged legal entanglement, binary recovery outcomes, or even total loss. Investments are typically long-dated (2–5+ years) and demand an interdisciplinary approach that combines financial, legal, and operational analysis. Analysts must assess asset coverage, recovery waterfall dynamics, creditor hierarchies, and enterprise value under conservative assumptions. In many cases, investors will work closely with bankruptcy attorneys, financial advisors, and interim management to preserve or enhance value through the turnaround.

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The investment process begins with screening for catalysts: covenant breaches, liquidity events, macro shocks, or public signals of distress. Investors then conduct forensic-level due diligence, evaluating whether the enterprise value justifies a position within the capital stack. Modelling recovery scenarios and stress-testing restructuring options is essential. Once a position is taken, the focus shifts to creditor engagement, plan negotiation, and ultimately to a monetisation strategy, be it through equity ownership post-reorg, asset sales, or recapitalisations.

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For professionals entering the space, distressed investing offers unparalleled exposure to real-world credit mechanics. It builds fluency in downside scenario modelling, teaches the legal intricacies of capital structure, and fosters a deep appreciation for how capital behaves in moments of pressure. It is a challenging but highly rewarding arena, reserved for those who are comfortable with ambiguity, complexity, and the pursuit of contrarian opportunity.