Thoma Bravo made headlines a couple of weeks ago after writing off $5.1bn of equity in Medallia, a company selling customer experience analysis software-as-a-service, in the second-largest private equity loss in history.
At the risk of getting ourselves typecast, Alphaville thought we’d ignore this faceplant and instead trace what happened with the company’s debt and its debtors — as the Medallia situation offers an intriguing way to explore the private broader credit industry.
And, while we’re there, we thought we’d also take a look at how private credit funds paid themselves for managing the position. Tl;dr: very well, thanks for asking!
Diving down the BDC rabbit-hole
One of the distinguishing features of private equity and private credit is the privacy afforded to portfolio companies.
So while we don’t know for sure, we think that around $1.8bn of debt was raised to support Thoma Bravo’s Medallia acquisition, back in 2021. And we can see that a lot of this maybe-$1.8bn-of-debt was bought by business development companies — private credit funds that tend to use leverage in the hope of delivering good returns.
One of the reasons Alphaville picks on BDCs is they’re a rare source of light in an otherwise shadowy private credit reporting environment. BDCs are obliged to file their holdings via the SEC every three months, along with basic deal deets, the nature of the leverage they are deploying and the fee structures they’re charging clients. By contrast, loans that go into other private credit funds pretty much disappear from our line of sight.
Here’s a chart showing how exposure to Medallia term loans due October 2028 has evolved across the BDCs we’ve spotted holding them:
It looks like the two largest Blackstone BDCs — BCRED and Blackstone Secured Lending Fund — acquired around $825mn of the debt at or shortly after origination. Back then, positions looked recklessly large: loans to Medallia initially constituted 5.2 per cent of BCRED’s net assets, and 6.5 per cent of the Secured Lending Fund’s net assets.
But BCRED was in its uber-growth phase, gathering new client assets with gusto. And while it looks like it used some of these new funds to purchase more Medallia debt, the avalanche of client money into BCRED was such that, by mid-2022, when it topped up its holding to over $1bn, the fund’s concentration to the name had fallen to a still-high-but-less-ridiculous 3.6 per cent of net assets.
It performed, until it didn’t
Lacking proper secondary markets, BDC managers can’t post actual prices on the private credit loans that they’re holding. But they do post their guesses as to what these loans might be worth. As far as we know there’s no conferring among managers prior to guesstimate-posting, so it’s not entirely surprising to see some dispersion across the marks.
Looking just at managers’ guessed fair value, it looks like cracks began to emerge at the end of 2024. And the position was held on ‘accrual’ — meaning that managers believed that it could still be expected to pay interest — right up to Q1 2026.
So far, so meh.
Sure, BDCs piled their clients’ funds into a loan that turned out to be a bit of a dud. But it would be silly to think that every single private credit loan is going to work out.
The interesting bit (to us at least) is taking a peek at how the loan’s terms changed, the mechanism by which the positions grew, and the economics of this position growth from the perspective of the BDCs.
Here’s how the interest rate payable by Medallia’s senior secured first-lien term loan due 2028 has evolved since the end of 2021:
In its first year the loan paid US dollar Libor (RIP 💀) plus 6.75 per cent. And this 6.75 per cent came in the form of new payment-in-kind debt. There’s a time and a place for PIK debt. And, while it didn’t turn out well in the end, lending Medallia on PIK terms made a certain amount of sense.
After all, profitable and fast-growing software companies that can use any spare cash for even faster expansion are precisely the kinds of companies that shouldn’t mind a slightly higher interest rate if it means they get to defer cash payments for a while.
And with overnight interest rates close to zero, Medallia was initially paying next to no cash interest. But if Medallia owed you $100 at the end of 2021, they’d owe you $106.75 by the end of 2022.
Fast forward to Q1 2026 and that $100 principal amount had grown to $122.5:
Multiplying this blue principal value by managers’ price guesses gets us to the red line — managers’ estimated fair value of that initial $100 principal amount. You can see that from mid-2024, things looked . . . problematic. Debt fair value was being marked down faster than new debt was being added to the pile.
But, according to one banker we spoke to, the real red flag was hoisted in the final quarter of 2023. Back on our stacked bar chart you’ll see that the cash spread payable jumped up to 2.5 per cent, shrinking the PIK component down to 4 per cent. This sort of thing, we understand, tends to happen only when business plans go awry, debt covenants are breached, that sort of thing. It doesn’t necessarily mean that fair value should’ve been marked down — after all, the thing was now spewing a bit more cash.
How did BDC managers manage the position?
Without a ready secondary market for direct loans, there’s arguably not a lot that a BDC can do once a loan on their books starts heading south.
Perhaps BDC managers engaged with Thoma Bravo and Medallia’s management in an effort to get the company to steer a new, creditor-friendly, course. That’s probably the most they could’ve done. Because it’s not clear that exiting their position in the bespoke market for direct loans was a realistic option. And in nominal terms, given the PIKing, the position grew and grew.
Any fund manager’s long-term interests are bound up with delivering excellent investment returns for their clients — enhancing their brands and creating sustainable value for their businesses. Despite this, fund managers like to get paid performance incentives, supposedly to incentivise them to, you know, get out of bed in the morning and do their jobs. And clients are seemingly willing to pay them.
Private credit managers charge a bunch of different fees. Schedules differ from fund to fund, but the ones we’ve looked at all include a base management fee on net assets (actual client money). Some (typically publicly-traded ones) layer on another fee on any money that the manager has borrowed to punt into assets. And all apply incentive fees.
Some readers familiar with the old hedge fund two-and-twenty fee model might assume that BDC incentive fees follow this pattern, where performance fees are charged on total returns above some hurdle rate. Such readers would be wrong.
The bulk of BDC incentive fees are instead levied on income — presumably on the basis that their punting is concentrated in senior secured private credit loans marked at, or close to, par that pay fat incomes.
Importantly, no distinction is made between cash income and PIK income. And this means that even if BDC clients are left mostly with a larger pile of non-performing debt, the BDC managers will have seen their quarterly base management fees and incentive fees grow and grow.
And, as BCRED’s latest 10-Q puts it:
. . . an election to defer PIK interest payments by adding them to the principal on such instruments increases our future investment income which increases our net assets and, as such, increases the Adviser’s future base management fees which, thus, increases the Adviser’s future income incentive fees at a compounding rate;
Huzzah! 🍾🥂
BCRED takes an eighth of investment income as an incentive, as long as a 5 per cent income hurdle is cleared. FS KKR Capital Corp takes 17.5 per cent if a 7 per cent hurdle is cleared. And this all adds up to some meaty total fees, both as a share of net asset value and in absolute dollar amounts:
And this is before we even start looking at shareholder servicing fees, and all the different professional service and administrative fees levied.
While a hedge fund needs to deliver outsized performance before it can start creaming off incentive fees, BDC managers need only to throw client money into loans that pay outsized income. And this means that rather than having to, you know, make money for their clients, BDC managers can pretty much diarise performance fees.
OK, it’s not quite that clean. Among the BDCs we looked at, Blackstone Secured Lending Fund BDC, aka BXSL, does have a wrinkle.
The fee structure contains a three-year lookback feature that depresses incentive fees when assets are marked down. And this feature contributed to total incentive fees in Q1 2026 being a mere $2.3mn, compared to $26.4mn the prior quarter, following markdowns. Still, fee rates for public BDCs like BXSL are not exactly measly — so let’s not shed a tear quite yet.
We tried to work out exactly how much BDCs had taken in fees along the way. We added up all the PIK ‘phantom’ income capitalised in the five BDCs that we identified as holding the debt, and this came to just over $300mn.
Unfortunately, because these funds use leverage and we don’t have a quick and easy way to estimate the cumulative apportioned costs of financing the Medallia position, we can’t just apply the funds’ respective income incentive shares to arrive at a total income incentive fee number. But we’d be surprised if it’s not a very large number.
Paying a fund manager a very low base management fee plus some performance fee when the bets they’ve made (with your money) turn out great has some logic. But paying a fund manager a fairly chunky management fee, and then an extra incentive fee that increases proportionately to the amount of credit risk they choose to expose you to (and proportionately to whatever overnight rate the FOMC chooses to set) is truly bizarre.
And it feels weird and wrong to us that what must surely be one of the most regrettable investment decisions so far made by BDC managers for their clients has mechanically added to rather than detracted from almost every manager’s total income.
Additional reporting by Antoine Gara
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