By Jen Saarbach & Kristen Kelly, Co-Founders of The Wall Street Skinny
At first glance, you might think private equity firms wouldn’t be too fazed by Trump’s proposed tariffs. After all, PE is a long-term, illiquid asset class. Investors can’t check their performance minute-to-minute like they can with public stocks.
But you’d be wrong.
The tariff chaos had private equity pros sweating — and for good reason. There were four major ripple effects that made PE firms nervous:
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No Exits = No Payouts
Private equity firms rely on IPOs and M&A to cash out of their investments (meaning the companies they bought and theoretically “turned around”), and return money to their investors or LPs. Exits were very light over the past few years and PE firms were banking on the new administration to reopen the M&A and IPO market.
But the tariff headlines threw cold water on that. Markets got shaky, and IPOs and M&A deals that were supposed to go live in the next few months had to hit pause.
No exits = no liquidity. That’s a big problem for firms looking to return capital which in many cases their investors — pension funds, endowments, foundations — needed. Which brings us to the next issue…
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The Denominator Effect Hit Hard
Big institutions — think pension funds and university endowments — invest in private equity as part of a diversified portfolio. Picture a pie chart with slices for stocks, bonds, real estate, and PE:
Now imagine the public markets tank. Stocks get marked down instantaneously, so the “pie” shrinks. But private equity doesn’t get revalued as quickly. Its slice stays the same — or at least appears to.
Suddenly, what was supposed to be a 10% allocation to private equity looks more like 15%.
That’s called the denominator effect. They’re suddenly even MORE overexposed to private equity without actually buying more. AND many limited partners (aka LPs) had come into this year already over their PE risk limits. It led to many frantic calls to PE firms looking to sell their GP stakes.
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Portfolio Company Performance
Because of the magnitude and extent of the proposed tariffs, almost no company would be spared performance-wise. As PE firms think about the future cash flows of their businesses, tariffs hit on multiple fronts:
- Lower Margins: Proposed tariffs would have meant higher costs as the price of imported materials rose.
- Lower Growth: Between lower profits and therefore a likely need to INCREASE costs, that impacts demand for products, not to mention retaliatory tariffs from other countries hurt the demand as well. All in all results in lower growth.
- Borrowing Costs: See ripple effect 4.
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Corporate Interest Rates Rising
Partly because of the risks outlined in #3, companies will have to pay more for their debt — which REALLY impacts companies that already have a lot of debt, like… companies owned by PE firms.
When companies borrow, they pay an interest rate that is made up of:
- Risk-Free Rate (like U.S. Treasuries or SOFR) + a Credit Spread
The credit spread compensates lenders for default risk, which just means: what is the risk of not being able to make interest payments?
Here’s a quick example of how it works:
- Treasury yield = 4.0%
- Spread = 1.5%
- Borrowing cost = 5.5%
If the company looks riskier, credit spreads widen, meaning their overall interest rate goes up.
And if Treasuries sell off (as discussed in our first article), those rates go up too — meaning their overall interest rate goes up EVEN MORE.
Companies with existing debt have an additional problem: their existing debt has “debt covenants” in place.
Debt covenants are just rules that are put into the credit agreement a company has with a bank that serve as an early warning signal about whether a company is at risk of default. If they trip a covenant, in many cases they may need to re-negotiate terms of their existing debt.
One common example of a covenant is a restriction on how much LEVERAGE a company can take on. For example, a covenant may say “You must maintain a leverage ratio under 6x.” How does this work?
Let’s say a company has:
- $400M in debt
- $100M in EBITDA → Leverage = 4x (<6x, so we’re safe!)
However, if because of tariffs earnings drop to $50M, this is what happens:
- $400M ÷ $50M = 8x leverage → They’ve breached their covenant despite not borrowing a dime more.
And again, covenant breaches can lead to forced restructurings, where our company is now far riskier with higher leverage levels and lower profitability. It’s just bad all around.
Bottom Line:
The tariff headlines didn’t just shake up public markets — they rattled private equity too. Now with the 90-day pause in place, everyone’s hoping for calmer waters.
But with so much uncertainty, Private Equity isn’t popping the champagne — or domestic sparkling wine — just yet.
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