Investing in distress debt

DAR ES SALAAM: IN the world of finance, there is a peculiar paradox. While most investors flee trouble, a select few move toward it with calculated precision.

They are the architects of what might be called “financial alchemy,” the ability to transform a company’s darkest hour into an acquisition opportunity.

This is the realm of distressed M&A, where companies on the brink of collapse become valuable assets and the path to ownership is rarely a straightforward equity purchase. Instead, the most sophisticated investors navigate a labyrinth of debt instruments, private financing structures and alternative investments, each carefully positioned to gain not just a financial return but also control over the company’s future.

The story of distressed M&A is a complex narrative of capital deployment, strategic positioning and the relentless pursuit of value creation in the most challenging circumstances. Debt financing, private financing and alternative investments are the primary entry points for investors to acquire distressed companies, thereby transforming financial crises into strategic opportunities.

Distressed debt investing is the strategy of deploying capital into the existing debt of financially distressed companies, governments, or public entities whose securities trade at a significant discount to par value, typically 30 per cent–40 per cent or more, reflecting elevated default risk and restructuring expectations.

A financially distressed company is one that has an unstable capital structure.

This could mean the company’s debt load is too high or difficult to refinance, or the company can’t meet restrictions on its current debt covenants. Distressed debt investors look for “a good company with a bad balance sheet.”

Debt is generally considered distressed when the issuer is near default or already in default, credit rating is very low (CCC or below), bond yields are extremely high (10 per cent above government bonds) or payments (interest/principal) are missed or restructured.

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The three things distress debt investors look for when assessing companies to invest in are: 1. Financial distress 2. A successful business model 3. An in-demand product or service When an otherwise successful company runs into problems with debt, a distressed debt investor can identify an opportunity and buy a portion of that debt with the goal of gaining a controlling position.

Distressed debt investors focus on gaining control in two situations: 1. Restructuring of a distressed company: If a distressed debt investor owns a controlling share of a company’s debt, it can influence its restructuring process and emerge as an equity owner. 2. Bankruptcy of a distressed company: In the case that a company can’t be restructured and must liquidate assets and pay stakeholders, debt holders are paid out before equity holders.

Top global firms that invest in distressed debt include Oaktree Capital Management, Apollo Global Management, Blackstone and Bain Capital. Billionaire investor Howard Marks who is the co-chief executive investor of Oaktree Capital Management is the most famous investor in the distressed debt. His fund size is approximately 220 billion US dollars as of December 2025.

Benefits and risks of distressed debt investing While distressed debt investments can be risky and difficult to execute, they can provide lucrative returns. Because of this high-risk, high-reward combination, distressed debt is often included as one small piece of a larger investment portfolio.

This way, the portfolio is diverse enough to spread out risk. Potential sources of risk in distressed debt investing include:

1. Lack of access to financial information: If you’re aiming for secrecy, due diligence is limited to a company’s public records.

This could lead to investment decisions based on an incomplete picture of a company’s finances.

2. Potential competition with other investors: Other distressed debt investors may be slowly buying the company’s debt over time and beat you to the majority share or gain seniority. When the restructuring process is triggered, these other investors become “accidental partners”. In this position, they may have the ability to block your efforts.

3. Future financial distress: Just because a company is restructured and an investor has gained an equity position doesn’t mean it’s guaranteed to do well financially in the future. This presents an added risk; even if your efforts pay off, the company could still fall into financial distress again.

Potential benefits of distressed debt investments include:

1. Seeing high returns through restructuring: This is the goal of distressed debt investing and the best-case scenario. If you’ve correctly assessed an opportunity, strategically purchased a controlling share of debt and the restructuring process has been triggered, you can influence the restructuring process and become an equity or debt holder in the revamped company, setting up for a return on your initial investment down the line.

2. Being paid out in the case of bankruptcy: If the company cannot be restructured and must instead liquidate assets and pay out stakeholders, debt holders are the first to be paid. While this isn’t the best-case scenario, you’ll still be paid out for your share, which you theoretically purchased when prices were low. In this case, your return on investment may not be astronomical, but it’s still a win for a distressed debt investor.