Private Credit Strain: Why Operators Are Key, According to Greg Head

In a recent LinkedIn post, Greg Head discusses a critical shift occurring within the private credit market, emphasizing the growing need for strong operational execution among portfolio companies. Head highlights that a significant portion of borrowers are now facing financial headwinds, necessitating a pivot from financial engineering to tangible business improvements.

Greg Head points out a stark reality: “40% of private credit borrowers are generating negative free cash flow.” He further elaborates that the majority of these struggling entities are portfolio companies backed by private equity (PE) firms. This situation arises from a confluence of factors, including the acquisition of numerous companies at high multiples between 2019 and 2021, coupled with a doubling of interest rates.

The Shift from Financial Engineering to Operational Execution

The traditional playbook of financial engineering, which often relied on low interest rates and easy access to capital, is no longer as effective. As Head notes, “The financial engineering playbook compressed.” This forces companies to rely on their underlying operational performance to generate the Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) required to service debt and deliver returns to investors.

Head draws on past experience, stating, “I have watched this cycle before.” He explains that when a company’s capital structure becomes strained, the immediate response is not typically to engage with bankers. Instead, the focus shifts to the operators who possess the skills to improve cash conversion, optimize pricing strategies, and significantly boost EBITDA within a short timeframe.

“When the capital structure gets tight, the first call is not to the banker. The first call is to the operator who knows how to compress cash conversion, restructure pricing, and move EBITDA 300 basis points in 12 months.”

This emphasis on operational expertise is becoming paramount as PE firms manage a substantial number of unsold companies. Head provides a striking statistic: “PE firms are holding 32,000 unsold companies worth $3.8 trillion right now.” Furthermore, he indicates a broader market cooling, with “LP distributions have fallen below 15% of NAV, the lowest level since 2008.” These figures underscore the pressure on PE firms and their portfolio companies to demonstrate real-world value creation.

The Operator’s Crucial Role

The current market environment, according to Greg Head, creates a significant demand for skilled operators. These individuals are essential for navigating the complexities of debt servicing and generating returns in a higher-interest-rate environment. Head posits that companies are now in urgent need of individuals who can drive tangible business improvements.

“Those companies need operators.”

The ultimate question for executives, as posed by Head, is their readiness to fill this critical role. He concludes by prompting introspection: “The question is whether you are positioned as one.” This suggests that for business leaders, developing and showcasing strong operational capabilities is no longer optional but a necessity for success in the current economic climate.