GERMANY Trends and Developments Contributed by: Michael Josenhans, Lucas Lengersdorf and Beatrice Zobel, Freshfields
Evolving Capital Structures: The Role of Holdco Debt and Preferred Equity Over recent years, private capital markets have seen a noticeable expansion in the use of holding compa - ny (holdco) payment-in-kind (PIK) debt and preferred equity. This phenomenon has been especially marked among businesses backed by private equity, where macroeconomic uncertainties and persistent infla - tionary pressures have tested conventional financing models. Investors and sponsors alike increasingly rely on holdco instruments, not only as an alternative for acquisition funding and portfolio growth but also to manage refinancing, bolster liquidity within complex group structures, and navigate the demands of share - holder distributions. Holdco financing provides a broad set of solutions, serving both thriving entities and those facing market headwinds. For shareholders seeking capital without surrendering ownership or burdening a company with immediate cash interest payments, holdco debt and preferred equity become tools of strategic importance. They can be embedded in new capital structures at inception or injected later to address emerging needs, such as acquisitions or return of capital to sharehold - ers. In stressed scenarios, such as when a business underperforms or is hampered by legacy financings set in more favourable interest rate environments, these instruments often become a lifeline – provid - ing interim funding on the path to eventual business turnaround or exit. Private credit investors have emerged as key partici - pants in this dynamic. Their ability to analyse across capital structures and tailor financing terms equips them to underwrite structural and jurisdictional com - plexities that may be less appealing to traditional lenders. The willingness to structure bespoke terms enables private credit funds to seize opportunities for risk-adjusted returns, staking claims at multiple tiers of the capital stack. Risks of holdco instruments: subordination and enforcement challenges Despite their strategic appeal, holdco instruments present unique challenges for lenders. The defining characteristic of holdco debt is its position beneath opco (operating company) senior debt. Holdco credi -
tors generally do not hold direct claims over the cash flows or assets at the operating company level. Instead, their recourse is limited to the holding entity itself or, in some cases, secured interests in shares of the holdco. Even where a share pledge exists, enforc - ing it may trigger disruptive change-of-control clauses in the opco finance agreements, potentially precipi - tating a broader crisis, diminishing asset values, and undermining the efficacy of any enforcement sale. The complexities of enforcement mean holdco credi - tors must rely less on traditional legal pathways and more on mechanisms that motivate shareholders to facilitate the timely repayment of debt. Achieving this alignment is not straightforward, but it is necessary in structures where a lender’s influence is limited com - pared to that of senior debt holders. At its core, this challenge has shifted market practice towards prior - itising rigorous contractual protections designed to encourage shareholder behaviour that supports credi - tor recovery. Protecting against value leakage One of the primary threats to investor recovery in hold - co deals is the risk of assets or earnings being leaked to shareholders or affiliate entities, reducing the pool available for debt service. Transactions involving divi - dends, inter-company payments, or investments in affiliates pose particular risks. Holdco finance docu - ments often build on opco precedents but go further: imposing stricter controls on restricted payments, affiliate transactions, and, crucially, rules governing so-called “unrestricted subsidiaries”. These vehicles can allow sponsors to move valuable assets outside the reach of creditor protections, circumventing legacy documentation and undermining the lender’s position. Effective controls in this area typically include the fol - lowing. • Exhaustive regulation of dividend and investment outflows – Ensuring that group cash and assets are not distributed or invested in ways that favour shareholders ahead of creditors. • Tighter procedures for designating unrestricted subsidiaries and related protections – Requiring creditor consent for such designations or imposing tests that preserve asset coverage and recovery
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