EXCLUSIVE: Treasuries Above 5% Create a New Problem for Private Equity: Why Buy Risky Assets?

A 10-year Treasury yield above 5% is creating a fresh challenge for private equity firms: convincing investors to lock up capital when government bonds offer a meaningful return with far less risk and more liquidity.

“At a 5% risk-free rate, private equity has to work much harder to justify locking up capital for years,” Mark Spindel, senior advisor and partner at Pilot Wave Holdings, told Benzinga.

The pressure adds to an already tough backdrop of a struggling exit market, expensive financing and the need to generate returns without leaning on leverage or multiple expansion. Treasury buyers, by contrast, take on no portfolio-company operating risk and don’t have to wait years for a sponsor to exit.

Spindel said capital isn’t necessarily leaving private equity, but investors are getting more selective. “The capital is still there, but the tolerance for an average manager is much lower,” he said.

That could favor established managers with strong track records and push others to show how they’ll create value after an acquisition.

Buyers Get More Disciplined

Higher Treasury yields can also raise financing costs and change how sponsors underwrite acquisitions.

"From the deal side, higher risk-free rates make buyers much more disciplined on price," Jack Pitts, co-founder and principal at Salt Creek Advisory, a lower-middle-market M&A firm, told Benzinga.

In the lower middle market, that doesn’t mean good businesses stop selling. Instead, buyers are becoming more selective, placing greater emphasis on recurring revenue, low customer concentration, strong management teams and consistent cash flow.

For weaker businesses, buyers may use less leverage, lower their purchase price or structure more of the transaction through earnouts and seller financing.

Selectivity Makes it Harder to Agree on Price

"Owners may still have a valuation in mind based on deals from a different rate environment, while buyers are underwriting against today’s cost of capital," Pitts said.

Spindel said a higher Treasury yield also makes the entry price less forgiving.

"A 5% Treasury yield makes the entry price less forgiving and puts much more pressure on the operating thesis," he said.

Higher borrowing costs can reduce the amount of leverage a deal can support and increase the equity contribution required from sponsors. That can force buyers to walk away from transactions that might have worked when financing was cheaper.

"The purchase price may need to come down. The equity check may need to go up. The sponsor may need a stronger operating plan," Spindel said.

Betting On Operations, Not Multiples

With less room for financial engineering, sponsors increasingly need to show how they can improve the businesses they acquire. Rather than relying on cheap debt or selling at a higher valuation, that could mean improving revenue, margins, productivity, or capital efficiency at portfolio companies.

"What disappears first is the ability to make an average deal look attractive because the financing is cheap," Spindel said.

For private equity, the higher-rate environment could therefore shift more of the return burden onto the underlying businesses themselves — and away from leverage and multiple expansion.

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