Investors often choose to make distressed debt investments in companies facing financial hardship. When a company finds itself in a turnaround situation and at risk of bankruptcy, investors typically choose to invest in debt over equity, largely because debt is paid out first in the event of bankruptcy. Although an equity investment produces much higher returns if a company successfully recovers, the significantly reduced downside of debt investing yields a higher expected value for investors.
In addition to turnarounds, distressed debt investing may involve lend-to-own situations. When companies have leveraged themselves too much and find themselves drowning in debt, investors can acquire large portions of that debt, knowing that the company will likely be unable to pay off the money it owes. If the company goes bankrupt, shareholders grant lend-to-own investors control of the company in exchange for not having to pay back investors.