How Rising Rates Changed PE Deal Structuring

The PE deal structuring playbook of the 2010s — maximize leverage at razor-thin spreads, ride the low-rate wave — is over. The interest rate cycle that began in 2022 has forced a fundamental rethinking of how PE firms capitalize acquisitions. Understanding the new debt landscape is non-negotiable for any deal professional.

The Rate Environment

Central banks raised rates aggressively through 2022-2023, moving financing markets far away from the near-zero environment that defined much of the 2015-2021 deal vintage. Any precise rate path should be checked against current central bank releases before publication.

SOFR (the reference rate for most leveraged loans) sits at roughly 4.0-4.3%, meaning a typical Term Loan B priced at SOFR + 400-500bps carries an all-in cost of 8.0-9.3%. Compare this to 2021, when the same loan might have cost 4.5-5.5% all-in.

How Capital Structures Have Adjusted

The higher rate environment has produced several structural shifts:

Lower leverage multiples: Average leverage on new LBOs has declined from 6.5x in 2021 to approximately 5.0-5.5x in 2025-2026. Lenders are more conservative, and PE firms are accepting that lower leverage is required to maintain adequate debt service coverage.
More equity contribution: Sponsor equity as a percentage of total sources has risen from 40-45% to 50-55% in many transactions. More equity means lower financial risk but also a higher return hurdle.
Fixed-rate preference: More borrowers are fixing rates through interest rate swaps or caps. The floating-rate risk that punished some portfolios in 2022-2023 has made hedging a board-level priority.
Private credit expansion: Traditional banks have pulled back from parts of the syndicated loan market. Private credit funds have filled the void, often providing hold-to-maturity loans with wider spreads and tighter documentation than the cheapest pre-2022 structures.
PIK toggles and deferred interest: To manage near-term cash flow, some deals include PIK (payment-in-kind) interest features that capitalize interest rather than requiring cash service. This preserves FCF but increases total debt outstanding over time.

Impact on LBO Returns

Higher borrowing costs mechanically reduce LBO returns. Consider a stylized example:

A $500M acquisition at 10x EBITDA ($50M EBITDA) financed with 5.0x leverage ($250M debt) and 50% equity ($250M). If debt costs 8.5% all-in, annual interest expense is $21.25M — consuming 42.5% of EBITDA. In 2021, at 5.0% all-in, interest expense would have been $12.5M — only 25% of EBITDA.

That additional $8.75M in annual interest expense directly reduces FCF available for debt paydown, weakening the deleveraging return lever. Over a 5-year hold, the IRR impact can be 300-500bps.

How Smart GPs Are Adapting

The best firms are not simply accepting lower returns. They are adapting:

Buying at lower multiples: Disciplined GPs are walking away from processes where sellers demand 2021-era pricing. The bid-ask spread is real, but so is the opportunity for patient buyers.
Operational alpha: With financial engineering contributing less, EBITDA growth becomes the primary return driver. GPs are investing more in operating partner teams and post-close value creation.
Creative structuring: Earn-outs, seller financing, and rollover equity are being used to bridge valuation gaps without loading up on third-party debt.
Shorter hold assumptions: Some firms are underwriting to 3-4 year holds rather than 5-6, assuming that rate cuts will improve refinancing conditions and exit multiples in the near term.

The Private Credit Opportunity

Private credit deserves special attention. The asset class has grown from $500 billion in 2019 to over $1.8 trillion in 2025. For PE deal professionals, this means:

Relationship matters: Unlike the syndicated market, private credit deals are relationship-driven. Knowing the right credit funds and their preferences can accelerate deal timelines.
Speed and certainty: Private credit lenders can commit capital in 2-4 weeks vs. 6-8 weeks for syndication. This speed can be a competitive advantage in auction processes.
Flexibility: Private credit lenders offer customized covenants, delayed-draw facilities, and unitranche structures that simplify capital tables.

Key Takeaway for Deal Professionals

The rate environment has made financial modeling more important, not less. Every basis point of spread, every turn of leverage, and every assumption about rate trajectory directly impacts returns. If you are building an LBO model in 2026, stress-test your base case with rates 100bps higher and lower. The days of levering up and hoping for the best are firmly behind us.