Private Credit Distress: The Software Workout Wave

Introduction

Read only the bankruptcy dockets of public companies and the 2026 restructuring market looks like it is cooling. Of the 100 large corporate bankruptcies Cornerstone Research counted in the twelve months to June 2026, only 20 were filed by public companies, against an average public share of more than half across 2005-2025. The rest of the work sits with private, sponsor-owned companies financed by direct lenders, and its sharpest edge is software: the sector private credit funded most heavily in the 2020-2022 buyout boom, now facing AI tools that threaten seat-based revenue just as its loans approach maturity.

This article covers why distress moved into private credit, why software sits at the center of it, how a private credit workout runs and why it rarely turns into a liability management fight, what the Medallia and Pluralsight cases show, and what the shift means for restructuring mandates on both sides of the table. For the full 2026 filing and default picture, start with where the restructuring market stands.

The public filing count fell because the borrowers changed, not because distress went away. Cornerstone's midyear 2026 report shows public companies falling from 36 of 117 large filers in the prior twelve months to 20 of 100, and it notes that several of the period's mega bankruptcies, First Brands among them, had borrowed from private credit lenders. Private credit's own growth explains much of the shift: Fitch Ratings, cited in the same report, estimates that global private credit assets doubled from $1 trillion in 2019 to more than $2 trillion by 2024. A decade of leveraged buyouts that once would have been financed with broadly syndicated term loans and high-yield bonds was financed instead with unitranche loans held by a handful of direct lenders.

Source: Cornerstone Research, *Trends in Large Corporate Bankruptcy and Financial Distress, Midyear 2026* (BankruptcyData).

The distress that never reaches a docket

When a privately financed company runs out of road, the fix usually happens in a conference room rather than a courtroom. The sponsor hands the company to its lenders, the lenders convert debt into equity, and nothing is filed. Lincoln International's data, reported by Debtwire in June 2026, puts private credit foreclosures at $2.7 billion in 2023, more than $10.7 billion in 2024 and more than $24 billion in 2025, with 2026 tracking well ahead of that. None of those transactions show up in a bankruptcy count, which is why the headline statistics understate how much restructuring work is being done.

The default measures tell the same story once they are read correctly. The Proskauer Private Credit Default Index recorded 2.51% for Q2 2026, down from 2.73% in Q1 and within its recent range. Lincoln's broader measures run higher: a covenant default rate of about 3% and a shadow default rate of about 5% once loans that switched to PIK after closing are included.

Shadow Default

A shadow default is a private credit loan that is technically performing but only because the lender agreed, after closing, to let the borrower pay interest in kind (adding it to principal) instead of in cash. Lincoln International tracks these "bad PIK" loans separately from covenant and payment defaults because the amendment avoids a reported default while the borrower is not generating the cash to service its debt. A rising shadow default rate signals restructuring work that has been deferred, not avoided.

Software was the favorite borrower of the private credit boom. The BIS March 2026 Quarterly Review estimates that private credit loans to software-as-a-service companies grew from almost $8 billion in 2015 to more than $500 billion by the end of 2025, about 19% of all direct loans. Lenders liked recurring subscription revenue, high switching costs and renewal rates that made cash flow look predictable, and many deals were written as recurring revenue loans sized on annual recurring revenue rather than EBITDA, with covenants designed to flip to cash-flow tests once the company matured.

AI and the seat-based business model

The thesis cracked in early 2026. The launch of Anthropic's Claude Cowork tools in the first quarter, which perform professional tasks that many software companies charge subscriptions for, set off a sell-off in software equity and debt. The BIS found that software stocks fell almost 30% between October 2025 and February 2026, while CNBC reported that Ares, Blue Owl and KKR each lost roughly 8% to 12% in a single week as investors repriced their private credit books. The loans most exposed are legacy SaaS businesses with seat-based pricing, where every job an AI agent absorbs can mean one fewer paid license.

Debt markets drew the distinction quickly. PitchBook LCD reported in August 2026 that the average bid on application software loans in the Morningstar LSTA index had fallen to about 87.75, down 9% on the year, while infrastructure, data and cybersecurity software loans traded several points higher. Application software alone accounts for $147 billion of leveraged loans outstanding.

The maturity schedule and the default projections

The pressure has a calendar. Morgan Stanley estimates that around 11% of software loans in direct lending mature in 2027 and roughly 20% in 2028, and in a March 2026 note its strategists projected direct lending defaults rising toward 8%, describing software borrowers as carrying the highest leverage and the lowest interest coverage of any major sector. UBS went further in February 2026, raising its worst-case default scenario for private credit to 15% if AI disruption proves rapid and severe.

The BIS Bulletin 128 adds two points that matter for restructuring bankers: a few large BDCs share exposure to a common pool of software borrowers, and neither BDCs nor their investors yet price software loans differently from the rest of their books. When the marks do move, they will move across several funds at once.

A direct-lending workout follows a different script from a broadly syndicated restructuring because the lender group is different. A unitranche loan is typically held by a small club of a handful of funds that originated it, intend to hold it to maturity, and know the sponsor from dozens of other deals. There is no secondary market of distressed funds buying in at 60 cents with a mandate to fight, and every lender is already at the table. The process therefore runs as a sequence of negotiated accommodations, each one costing the sponsor or the lenders a little more than the last.

Many situations stop at the amendment or the extension. In the syndicated market, the software credits that refinanced in 2026 paid for it: Thoma Bravo-backed Proofpoint extended $4.3 billion of its first-lien term loan to 2030 at SOFR plus 450 basis points, against SOFR plus 300 on the portion left unextended, and Sophos completed a cross-border amend-and-extend after talks on a private credit refinancing fell through. In private credit, PitchBook reports that most software deals getting done are refinancings and extensions by incumbent lenders, because new lenders are reluctant to take on legacy software risk. The broader menu of first-line tools is set out in amendments and waivers.

Handing over the keys

The defining 2026 outcome is the keys handover. The sponsor concludes that its equity is worthless and that funding the company further is throwing good money after bad; the lenders conclude that owning the business beats a fire sale in a market with few buyers for stressed software. The trade, in the words of a Cleary Gottlieb partner quoted by Debtwire: "sponsors get their release, lenders take the equity." The lenders typically equitize most of the loan, leave a smaller loan the business can service, inject new money pro rata and install a new board, while the sponsor receives a release from claims in exchange for a cooperative handover.

The documents make this easier than in the syndicated market. Private credit agreements give a concentrated lender group clearer foreclosure rights over the equity of the borrower, and the remedy can be exercised through a consensual transfer or, if needed, a UCC Article 9 sale without a bankruptcy filing. The sponsor-side calculus behind the decision to walk away is covered in how sponsors respond when portfolio companies struggle.

The 2020-2025 wave of uptier exchanges and drop-downs depended on conditions the private credit market mostly lacks. An aggressive LME needs a dispersed lender base that can be split into a favored majority and an excluded minority, loose documents with baskets to exploit, and lenders who will never face the sponsor again. In a club deal, the lender a sponsor would prime is often the same fund financing three of its other portfolio companies, so the reputational cost of a non-pro-rata deal is immediate and large.

The exceptions show the limits. In June 2024, Vista Equity Partners moved Pluralsight's intellectual property into an unrestricted subsidiary and used a new financing against it to meet an interest payment, a drop-down that was permitted by the credit agreement but angered a lender group that included Blue Owl, Ares, Goldman Sachs Asset Management and Oaktree. Two months later the same lenders took 100% ownership of the company in a recapitalization that converted roughly $1.2 billion of debt to equity and wiped out Vista's equity in a business it had taken private for $3.5 billion in 2021. The LME bought weeks, not a different outcome, and cost the sponsor goodwill with lenders it still needed elsewhere.

The clearest 2026 case is Medallia, the customer experience software company Thoma Bravo took private in 2021 at a $6.4 billion valuation. The financing was a recurring revenue loan from a private credit group led by Blackstone, with Apollo, KKR, HPS and others alongside. The loan allowed the company to pay part of its interest in kind while it worked toward profitability, and it was meant to convert to a traditional cash-pay structure once Medallia hit performance targets. It never did. PIK interest and add-on acquisitions (including Mindful and Thunderhead) took the balance to about $2.8 billion, among the largest private credit restructurings on record.

According to Octus, the lenders let the PIK arrangement expire at the end of 2025. The loan's new terms would have lifted annual debt service by about $100 million to roughly $300 million, against annual earnings of about $200 million reported by Bloomberg. The marks had already moved: Blackstone Secured Lending Fund carried the loan at 77.75% of par at the end of 2025, HPS marked it at 69 cents by February 2026, and Blackstone Private Credit Fund put the loan on non-accrual at the end of March.

Non-Accrual Loan

A non-accrual loan is one on which the lender has stopped recognizing interest income because it no longer expects to collect the contractual payments in full. For a business development company, moving a loan to non-accrual is the clearest public signal that a private credit borrower is in trouble, since BDCs disclose non-accruals and fair-value marks every quarter. Cornerstone Research found that non-accruals across BDC portfolios rose from 0.7% to a peak of 1.0% of fair value in the year to mid-2026, still well below pandemic levels, while the share of PIK loans held above 12%.

Thoma Bravo declined to inject new equity. With Kirkland & Ellis advising the company and Latham & Watkins the lenders, the group agreed to equitize the debt, and in June 2026 Medallia announced that a Blackstone-led creditor group would take it over, with Blackstone, Apollo and FS KKR investing $150 million of new capital.

For restructuring bankers, the move into private credit changes who hires them and what the work looks like. On the lender side, the clients are a few very large managers (Blackstone, Apollo, Ares, Blue Owl, HPS, Golub, KKR) that run in-house workout teams and hire financial advisors when a loan is about to become an equity position: building the business plan the lenders will own, valuing the company on a realistic post-AI revenue path, sizing the go-forward debt and negotiating governance. Debtwire reported that Blue Owl is hiring operating and restructuring executives for portfolio companies it ends up owning, a sign that lenders expect to hold more of these businesses. On the company and sponsor side, the advisor runs liquidity and the 13-week cash flow, tests whether new sponsor equity is worth the risk, and negotiates the release that lets the sponsor exit. How those two seats differ in practice is set out in debtor-side versus creditor-side mandates.

The economics differ too. Out-of-court handovers carry no fee applications, no public docket and less league-table credit, and they can take months to close because each step is a negotiation. Houlihan Lokey's results show the pattern: its Financial Restructuring revenue for the quarter to June 30, 2026 was $119 million, down from $128 million a year earlier, on 23 closed transactions against 35, which the firm attributed to the timing of closings. On the earnings call, management described restructuring activity as elevated amid dislocation in private credit and software and said its software advisory investments position it for software restructurings over the next two to three years.

The valuation problem at the center of every software workout

Every keys handover turns on one number, the restructured enterprise value: what the software business is worth if AI keeps compressing seat-based revenue. That makes the valuation work harder than in a typical operating restructuring. Recurring revenue multiples from 2021 are irrelevant, cash flow is often thin because the business was built for growth, and the comparable set is moving as public software multiples reprice. Advisors build cases on net revenue retention, gross margin, the share of revenue at risk from AI substitution and the cost of rebuilding the product, then translate them into a capital structure the business can carry. The Fed's September 2026 increase, which took the target range to 3.75-4.00% according to the FOMC statement and was its first hike since 2023, adds to the burden, because unitranche loans carry floating rates and every increase in the base rate flows straight into interest expense.

The private credit software cycle is still early. The largest maturities fall in 2027 and 2028, lender patience with PIK is already shorter than it was, and the funds that own these loans face redemption and mark scrutiny of their own, which the broader private credit stress picture covers from the investor side. For the asset management consequences, see how the private credit boom is reshaping asset management M&A; for how direct lending reset the floor on LBO valuations, see the private credit boom and LBO financing. The next article in this section turns from private workouts back to the courtroom, and to the ruling that redefined what a Chapter 11 plan can impose on parties who do not consent: Purdue Pharma and the end of non-debtor releases.