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When Vista Equity Partners moved some IP assets of its portfolio company Pluralsight into a subsidiary and then raised new money against those assets earlier this year, it appeared to be the sort of hardball restructuring maneuver that breached protocol for private credit.

After all, some of the commonly cited merits of private credit are stricter covenants and restructuring negotiations that include just a handful of lenders rather than dozens in more widely syndicated loan deals. Because private credit is such a relationship-oriented business, with lenders and sponsors often working together repeatedly, a liability management exercise (LME) was generally thought to not happen.

That’s why Vista’s apparent attempt to pull collateral from Pluralsight’s creditors, which include A-list lenders like Blue Owl, Goldman Sachs, Golub, BlackRock, Benefit Street Partners, Ares, and Oaktree, stirred controversy — for a moment.

The move is normally used to get new cash into a company, and Pluralsight, a workforce development and software company, was in need given performance and liquidity problems.

But in somewhat anticlimactic fashion following all the hoopla around the LME, the company is now exploring restructuring options, including lenders potentially exchanging their debt holdings for a majority ownership stake in the business, per 9fin sources.

Reports of that that possible restructuring began circulating just weeks after the initial news broke that the company was pursuing a J. Crew-style LME and that the sponsor was putting new money into the company.

In the end, Vista’s move bought the borrower very little additional runway, seeing that loan covenants restricted Vista to raising around $170m, sources said. It only raised $50m out of that maximum amount following the LME, adding to the company’s outstanding $1.3bn debt facility. That new debt, which primed the existing debt, was funded by Vista, according to 9fin sources.

This chain of events left some direct lenders and lawyers that 9fin spoke to a bit perplexed — most sponsors typically do not undertake such hostile action with creditors lightly, particularly in an asset class where such LMEs are considered somewhat unprecedented. For Vista to do so at potentially great reputational expense, only to prepare to possibly cede control of the business weeks after, makes matters even more puzzling.

“Vista especially is very particular and protective of their direct lending relationships. It would be incredibly surprising if they decided to burn those over one deal,” said one senior direct lending executive.

And, why risk that only to potentially hand control of the business to lenders shortly thereafter anyway?

“You never see a sponsor throwing good money after bad like this. And if you do see this kind of LME, it usually buys a lot more than a few weeks,” said a restructuring lawyer.

Let’s begin with the simplest explanation: Pluralsight simply couldn’t raise additional money after the LME.

Pluralsight only raised $50m off of the IP assets dropped into the subsidiary. It is possible that it could not raise more money needed beyond that to buy more runway for the struggling company, leading it to give up on the play and cede ownership

While that explanation is plausible, sources noted that it doesn’t address the confusingly underwhelming best-case scenario for this play: even if Pluralsight did successfully raise more money, it would be capped at $170m due to restrictions in the docs, a fraction of the company’s $1.3bn outstanding debt.

Furthermore, the $50m that was raised through the LME was used to fulfill the company’s interest payments rather than increase liquidity, which could suggest that the priming that occurred with the new money injection could simply be a byproduct of that method of raising cash.

So Vista injected $50m in the company following the LME, which was then used to make interest payments, all before the company begins exploring a restructuring in which one of the outcomes is to hand the business over to creditors.

This is not typically how drop-down LMEs play out, which prompted questions about whether the LME ever really had any teeth to it to begin with, in the sense that it may have never been employed as a hostile play designed to improve the sponsor’s recovery at the lender’s expense, as similar LMEs are often designed to.

Here are two other ways to explain why Vista would undertake an LME that ultimately did little to stave off a restructuring:

The first is that the firm simply didn’t know the maneuver would be so ineffective at buying time for the borrower. This is complicated by the idea that Vista would have presumably known the limitations of the LME before implementing it, however

The other explanation is that the professionals at Vista and their lawyers at Kirkland & Ellis knew their credit docs and knew the limitations of this maneuver to begin with but went through with it anyway. Working with this assumption, Vista must have carried through with it for some benefit they expected to derive from the maneuver beyond recovering their investments in Pluralsight, which the maneuver was clearly not capable of achieving. Perhaps it was never the goal to begin with. That expected benefit must have outweighed the potential negative consequences of implementing such an escalatory maneuver for Vista to consider it worthwhile. There’s also the possibility that the negative impact on creditor relations could be mitigated in a less apparent way

Several lawyers, lenders, and sponsors that we spoke to were not entirely convinced by the first explanation, saying that it simply didn’t make sense at face value.

“These are sophisticated actors, I highly doubt that this was someone doing something dumb — this was likely someone doing something very smart. It’s just a question of exactly what,” said the restructuring lawyer.

This led some to consider alternative reasons for the transaction — what benefits could Vista see from an LME that is perceived as aggressive, but is in reality harmless?

Some market participants argued that it could have been an exercise done by the sponsor to show LPs that they were willing to go to these lengths to preserve capital. They added that this type of move might be particularly helpful in the context of a tougher fundraising year for PE sponsors more broadly.

One senior direct lending executive we spoke to highlighted the importance of managing LP relationships as a consideration of the sponsor. But Vista also has to manage lender relationships, which brings us to the second question: would some positive optics with LPs be worth potentially burning bridges with lenders, or was there some way Vista managed to placate lenders despite the LME?

As another lender put it, “I get that they would want to show LPs that they were trying their best…but I don’t think they would upset lenders just to please their LPs with a useless move.”

This makes sense, unless the move upsets lenders less than it would appear to. To begin with, it changed little in the end — lenders may take over the business and appear no worse off after Vista’s maneuver, despite the controversy. In this sense, Vista did not really do such a terrible thing to its creditors, even if initial impressions suggested that they were attempting a J.Crew-like maneuver.

Lenders we spoke to also indicated that Pluralsight’s creditors could have known that they would ultimately take over the business, as they may after this restructuring, despite the LME.

Pluralsight’s lenders signed a cooperation agreement amongst themselves on 1 March, according to 9fin sources, while the LME occurred in April. Restructuring news (including potentially handing the business over to lenders) broke in early July.

For what it’s worth, the senior private credit executive we spoke to was familiar with the company but ultimately passed on participating in the original $1.3bn financing because of both the terms, which included looser covenants than they were comfortable with, and the business model: “There wasn’t the most convincing story on recurring revenue, it was very focused on a niche area of services.”

Since the new money was used to fund interest payments and keep Pluralsight current on debt, sources also noted that existing lenders could receive some accounting benefits from avoiding an event of default on the company’s original debt package.

An event of default, like a missed interest payment, would force lenders to update their loan marks and realize losses, which is one of the less rewarding parts of being a portfolio manager. With that default event avoided, lenders may be able to sidestep having to mark realized losses on the deal, particularly if their debt is ultimately converted into equity, which would be a much tidier outcome for lenders.

Typically, if a borrower is at risk of missing an interest payment, sponsors and lenders have tools to avoid an event of default, like providing a non-cash paying PIK instrument. A drop-down LME is hardly a go-to maneuver in this situation. However, it could prove to be a win-win for the sponsor and lenders in this case — the sponsor may get to look like they did all they could to hold on to the company, while the lenders could avoid the event of default and resultant loan markdowns.

One caveat that sources mentioned is that the lenders’ public business development company (BDC) vehicles showed wide variation in their Pluralsight marks as of the end of the Q1 (pre-LME,) with Golub marking it near par at 97 cents, and the rest marking it around 85 to 90 cents on the dollar. Ares, which marked its Pluralsight debt at 84.9 cents on the dollar, and Blue Owl, which marked it at 83.5, had the lowest valuations as of the end of Q1.

Avoiding an event of default is much more consequential for a lender who’s marked the loan near par than it is for a lender who’s already made meaningful markdowns on a loan, because a default for a lender who marked it near par would result in markdowns that appear much steeper and more abrupt than they would for a lender who had already indicated some distress in their marks in previous quarters. So it was not an equal incentive for all lenders, but could have been a greater incentive for those who marked it closer to par.

Nonetheless, one source noted that even the lenders who had marked the loan down to around 85 to 90 cents on the dollar, which constituted the majority of lenders as of the end of Q1, could have had to contend with even steeper markdowns had an event of default occurred than they will in this scenario, with the company current on its debt.

“If this was public, that debt would be trading in the 30s [cents on the dollar]” said the restructuring lawyer.

So, BDC marks being as high as they were suggests that all of the original club lenders likely avoided further loan markdowns in the quarter by avoiding an event of default.

One private equity sponsor we spoke to added that an LME may have been used to fund interest payments, rather than simply using something like PIK, because the existing lender club may not have all been willing to agree to provide a PIK. Thus, an LME could have bypassed the need for lender consensus.

Perhaps Vista’s relationships with creditors will remain intact, and this LME may still be considered innovative in private credit but not for the reasons that we initially thought.

Speaking to sources, Pluralsight’s action is not the first private credit ‘J.Screwed,’ but it is a case study that demonstrates some of the less obvious potential functions of an LME in private credit.

Ares, Benefit Street, BlackRock, Blue Owl, Goldman, Kirkland, and Oaktree declined to comment for this story.

Representatives at Vista, Pluralsight and Golub did not respond to requests for comment. Ducera, which advised Pluralsight, and Centerview and Davis Polk, which advised Pluralsight’s lenders, did not respond to requests for comment.

For now, Vista opting to go down the LME path is novel for the asset class. Considering the unique considerations of this situation, lenders we spoke to don’t currently anticipate too many more of these sorts of these LMEs.

“We’re getting so many questions about Pluralsight,” said the senior direct lending executive, “but I don’t think we’re going to see that many of those situations come to the market.”

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