From targets to term sheets Can KPI-linked debt support decarbonisation in private equity?

Portfolio companies are moving from setting science-based targets to funding delivery. This article explains how KPI-linked debt can support decarbonisation, where its value lies and why robust KPI design matters.

Portfolio companies have spent the last few years setting science-based targets, implementing management systems and developing decarbonisation plans. For many, the biggest challenge is understanding how they will be funded and delivered within the investment period.

One such solution is a sustainability-linked loan (SLL), which can be particularly valuable at refinancing. By linking borrowing costs to sustainability performance, SLLs create a financial incentive to meet agreed targets.

However, the market has become more selective, with sustainability-linked issuance across bonds and loans falling by roughly half in the first half of 2026 compared with the same period a year earlier. The number of SLL deals also fell by more than 40% in 2025. This does not necessarily mean the mechanism is broken, but it may indicate that lenders and borrowers are applying greater scrutiny as to whether a structure is credible and commercially useful.

A SLL is unlikely to fund an entire decarbonisation programme, but it can positively contribute financially; we have seen this first hand with our clients. Its role is also to create accountability, supporting better decisions and helping to fund the analysis, monitoring and assurance needed to unlock larger investment.

What is an ESG margin ratchet?

An ESG margin ratchet sits within a sustainability-linked loan and adjusts the interest margin according to performance against agreed sustainability targets. If those targets are met, typically borrowing costs fall; yet, in some structures, costs can also rise when targets are missed. However, around seven in ten ESG ratchets in private credit are one-way, meaning strong performance is rewarded without a corresponding penalty for underperformance.

Additionally, most ratchets move the margin by between two and fifteen basis points. On a £150 million facility, a ten-basis-point reduction is worth £150,000 a year. That is a meaningful contribution to decarbonisation programmes but not to capital required for an industrial site or a large property portfolio.

The wider value lies in putting a sustainability metric into the credit agreement. This requires the lender, management team and sponsor to agree three core points:

· What will be measured?

· How will performance be evidenced?

· Who is accountable for delivery?

In private equity-backed businesses, these decisions are often made during a fast-moving financing process, sometimes without sustainability specialists directly involved. Once agreed, a KPI can remain in place for the life of the facility. A target that looks reasonable at signing may become difficult to use if it has not been tested against the business plan or the available data.

Why financial incentives are only part of the value

Operational benefits

Well-designed KPIs are linked to activities that also improve business performance. This could include reducing energy use, strengthening supplier engagement or improving the quality of emissions data. Where that link is clear, the portfolio company can benefit both from the margin saving and from the operational improvements delivered by the underlying work.

In many cases, those operational savings will be more significant than the margin adjustment. An energy efficiency programme that cuts operating costs and pays back within three years is likely to have a greater impact on EBITDA than the ratchet itself. The financing incentive can still be useful, but it should support a sound operational case rather than substitute for one.

KPI quality expectations

Expectations around KPI quality have also tightened. The LMA Sustainability-Linked Loan Principles and related guidance emphasise materiality, ambition and verification. Targets need to go beyond business as usual, while external verification of performance is now common. Structures that reward success without a meaningful consequence for failure are also becoming harder to justify.

Risks of poorly designed KPIs

Poorly designed KPIs can therefore create financial and reputational risk. A KPI that cannot be measured consistently, supported by evidence or aligned with the way the business operates may become a liability. For a sponsor, a missed target may also reappear during exit diligence, when a prospective buyer reviews whether the business has delivered against its financing commitments.

The growth trap: scope 3 emissions

One of the most common design problems is an absolute scope 3 emissions KPI based on spend data.

As a company grows, procurement spend often increases. Reported emissions can rise with it, even where suppliers are reducing carbon intensity or the business is making genuine progress. The KPI may then reflect changes in spend more strongly than changes in environmental performance.

This is particularly relevant in private equity, where growth may be central to the investment thesis. A buy-and-build strategy can increase revenue, headcount and procurement at the same time. If the KPI does not account for this change, a successful value creation plan can make the sustainability target harder to achieve, even as the underlying business becomes more efficient.

A stronger structure looks beyond a single headline emissions figure and considers the drivers of longer-term decarbonisation. Depending on the business, suitable measures might include emissions intensity per unit of output, the proportion of suppliers with validated targets, delivered energy reductions or improvements in data coverage and quality. The right measure is the one that remains meaningful as the business changes and can be evidenced consistently each year.

How BIP.Verco supports credible KPI-linked debt

BIP.Verco works with sponsors and portfolio companies to design KPIs, cost the delivery plan behind them and put in place the monitoring needed to evidence performance.

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