Europe's private capital asset class has split into two markets that barely resemble each other, said advisers and fund managers at the SuperReturn International event in Berlin earlier in June. At one end sits a narrow band of prized assets drawing fierce competition from funds and lenders, while at the other there's a growing backlog of companies struggling to find a buyer.

"It's a bifurcated market," confirms Matthias Weissinger, partner at McDermott Will & Schulte. "There are very good assets that everyone is running towards, and that's driving down pricing and terms in the mid-market. Then there's a bunch of stuff that no one really wants to touch."

Meanwhile, the deals in-between these two groupings — which are deemed to be merely acceptable — are often seeing sales processes stall, market participants said. Adding to the complexity, buyers are also grappling with AI disruption and geopolitical uncertainty, which has increased the potential for valuation mismatches.

Shape shift For all these headwinds, the market's resources remain plentiful as private credit funds continue to raise large pools of capital and lenders remain eager to deploy it — though participants say their conviction is increasingly concentrated on a narrow group of assets.

That dynamic is reshaping Europe's private capital markets. Private credit has become the financing tool of first resort for sponsor-backed transactions, panellists at SuperReturn said, with much of today's activity revolving around refinancings, repricings and amend-and-extend transactions rather than new buyouts.

Volume level Private credit managers say they remain busy — though increasingly in terms of volumes rather than deal count. Mattis Poetter, partner and chief investment officer at Arcmont Asset Management, said the firm had enjoyed a strong first half despite M&A volume remaining below last year's levels. While Poetter expects the firm to complete fewer deals this year, he says overall financing volumes could rise as lenders move upmarket and finance larger transactions.

"This year, with the BDC competition gone and the liquid markets being volatile, you will see us selectively pivoting up a little bit where it makes sense," Poetter said. "If we can finance a €150 million to €200 million EBITDA business with similar terms, pricing and structures as we would a €50 million one, that's very interesting."

Meanwhile, the retreat of some of the market's most aggressive market players has also shifted negotiating power back toward direct lenders. "The most aggressive player on the market, which was the BDCs, has gone," Poetter said. "That affects pricing, terms and leverage in a positive way for us. It's much more lender-friendly than last year."

The competitive picture has also been shaped by the behaviour of the large US managers, noted several participants at SuperReturn. Those firms typically run lean teams in Europe and lifted the region's share of their private credit deployment sharply when liquidity was abundant, only to pull back as conditions tightened. Against this backdrop, most of the large US-managers have also turned "highly selective."

Even so, sources say finding transactions remains difficult because so few assets command broad conviction in the market. "The good assets are few and far between," said Weissinger at McDermott Will & Schulte. "Everyone knows they're good, and everyone chases them."

Market overhang Underlying the market is a growing backlog of unsold portfolio companies. Friedrich Bieselt, head of Lincoln International's Business Services Group in Europe, estimates that private equity firms are holding roughly two-and-a-half times more companies than they are currently bringing to market.

"There is a lot of overhang in the European private equity markets," Bieselt said. "People are holding too many companies for too long, more than continuation vehicles and other solutions can absorb. They need to learn again to deal with risk, and price it in their bids instead of walking away completely."

Crucially, this imbalance is increasingly pushing sponsors toward alternatives to outright sales.

Indeed, one private credit lawyer said roughly half his practice now consists of restructurings, portfolio work, refinancings and amend-and-extend transactions tied to that backlog. Such measures work until a company needs fresh capital rather than more time, he said. "Then it's difficult."

Options such as continuation vehicles, refinancing transactions and dividend recaps have helped relieve some pressure, participants at the SuperReturn event said, but are unlikely to solve the industry's broader liquidity challenge.

Price point The market bottleneck ultimately comes down to pricing, as many sponsors acquired businesses during the valuation boom of 2021 and 2022, and remain reluctant to sell below those levels.

"If you have a really good asset, you may still be able to achieve a good price, while others just keep it until valuation levels normalise in certain sectors," said Armin Sieber, head of financial sponsors coverage at Carlsquare.

However, that approach is becoming harder to sustain as funds age. "The pressure is increasing as funds are running out and they need to deliver DPI [Distributions to Paid-In Capital] to their LPs in order to raise new funds for further investments," Sieber added.

An M&A lawyer confirmed that pricing continues to be one of the market's central challenges. "The LPs don't want to realise assets at a lower price," he said. "Everyone wants to make money."

According to a partner at a private equity firm, the consequence of this type of market is that only the strongest assets are making it to completion. "Good companies sell for good prices, and mediocre companies don't sell at all," he said. "Many deals that would have gotten done five years ago just don't happen anymore."

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Slower process In cases where deals do emerge, buyers are taking longer to make decisions. Diligence processes that once took a few weeks can now run six to eight weeks or longer, sources say, with investors conducting increasingly detailed reviews of supply chains, customer concentration, AI exposure and operational resilience.

For their part, sellside advisers said execution rates have fallen sharply as buyers become less willing to use creative pricing and structures as a tool for risk assessment. In a way they have unlearnt the art of negotiating, and might decline attractive opportunities entirely if the slightest risk discussion arises, said Bieselt at Lincoln. "Bridging the parties has become a very difficult endeavour," he added.

Such caution is also reshaping the documentation for deals. Lenders are scrutinising EBITDA definitions more closely than almost anything else — particularly in the €20 million to €25 million EBITDA segment where covenant-lite structures, springing covenants and EBITDA adjustments remain common.

"If lenders are focused on one thing at the moment, it's the EBITDA definition, because it goes to the heart of everything in the documents," added McDermott Will & Schulte's Weissinger.

Go with the flow The market's growing selectivity is also changing the dynamics of capital flows, with industrial technology, infrastructure-related businesses, financial services and defence repeatedly cited at the SuperReturn conference as areas that are attracting investor interest.

"What's regarded as high quality has changed," said a partner at a German private equity firm. "Two years ago, high quality meant a SaaS company. But now it's an industrial tech company with high product differentiation and a good production footprint." Investors are also becoming more selective within software rather than abandoning the sector altogether, participants say.

Defence is another beneficiary of investors' search for resilience, with lenders and sponsors setting up special 'task forces' as they look for more opportunities in this space. What's more, the 'defence' label is itself being stretched. Sources say businesses with only a small slice of defence revenue — sometimes as little as 5% — are now being marketed as defence companies. "It's interesting how deals are labelled as defence," Weissinger said, estimating that roughly a fifth of the opportunities currently crossing his desk are marketed with some form of defence exposure, despite limited direct involvement in the sector.

M&A supply For all the structural pressures discussed above, participants at the Berlin event returned repeatedly to a single constraint — namely M&A volume.

Almost every problem in private credit, they said, eases once companies start changing hands again. The current impasse is largely one of pricing, with sellers anchored to old valuations and buyers unable to justify them at today's cost of capital. Deal volumes a few years ago were probably unnaturally high, panellists said, and the current pace may be closer to normal than it feels.

"The path ahead is straightforward in principle," one panellist stressed. "Pay less for businesses, find the clearing price, and make the return work from a lower entry point."