Sun Capital Partners Inc. has proven its bona fides as a turnaround and distressed specialist since inception in 1995, but its mission of snapping up struggling businesses is running into daunting challenges. In the past 13 months, the Boca Raton, Fla., firm has had 10 portfolio companies land in bankruptcy, five in the past three months. Many of them were in vulnerable sectors and were strained by lack of liquidity amid unprecedented economic conditions.

Now the firm may be treading a new path to try to preserve some bankrupt portfolio assets -- by providing debtor-in-possession financing. In recent weeks, it's come to the aid of at least two holdings: auto parts supplier Fluid Routing Solutions Inc., which filed for Chapter 11 Feb. 6, and tire retailer Big 10 Tire Stores Inc., which skidded into bankruptcy court April 2.

Sun may not be alone. Increasingly, signs point to investors turning private equity conventions on their head. Taking their cues from distressed debt specialists, intrepid investors appear to be drawn to loan-to-own strategies by buying debt in troubled businesses that may or may not be their own. This is clearly nontraditional terrain for private equity, and certain funds have been hurt by going in too early in this cycle, but investors believe there are attractive gains to be made through substantially discounted debt and DIP financings, especially when investment opportunities are few and far between.

"As this recession drags on, there aren't that many alternatives to make deals happen, but there are some very good businesses that are just overlevered that will become targets," says Edward Reilly Jr., a partner at New York law firm Goodwin Procter LLP. "People are going to learn how to play in this space."

Any number of firms -- mostly distressed experts such as Oak Hill Advisors, Oaktree Capital Management LP and Angelo, Gordon & Co., for now -- are trying to raise capital for distressed-debt activity, lawyers and investment advisers say. Blackstone Group LP's GSO Capital Partners LP is in the market for a large debt fund, GSO Capital Solutions Fund LP. Its offering documents don't specify the target size, but reports have pegged it at $3 billion. The GSO vehicle is structured as a private equity fund, says a source who requested anonymity. Its focus is defined broadly as providing liquidity to companies, including those in capital-structure transformations due to pending covenant violations, debt maturities and cyclical downturns.

Blackstone declined comment, citing regulatory constraints.

Others are wading in, in some cases carving out existing pools of capital. Goldman, Sachs & Co. hopes to invest as much as $4.5 billion in distressed corporate debt, about half of the remaining $9 billion in its 2007 fund. New Mountain Capital LLC of New York and at least two others, JLL Partners Inc., also of New York, and Leonard Green & Partners LP of Los Angeles, have similar approaches.

"Many private equity firms, particularly in the middle market, are considering how best to take advantage of opportunities in the marketplace today and the opportunities which they expect to arise out of the current market dislocation," says Peter Von Lehe, managing director at NB Alternatives, the alternatives business of Neuberger Berman Management Inc.

With the enormous void in the markets, DIP lending is particularly attractive because the spreads, or yields, on the securities are at all-time highs. "Without even trying, you're in the midteens, but they go well into the 20s," says one private equity investor. "The liquidity premium on this product is unprecedented."

Aladdin Capital Management LLC, a little-known investment firm in Stamford, Conn., is trying to raise $500 million to invest solely in DIP financings. The firm declined comment, but in January, Aladdin, known primarily as an asset manager active in collateralized loan obligations, announced a shift away from CLOs, moving broadly into asset-based lending, starting with DIP loans. It enlisted two ex-DIP veterans, Victor Russo and Luke Gosselin, formerly with CIT Group Inc., to coordinate investments. Unlike Sun, however, Aladdin isn't looking to own but to reap gains from facilities in the $75 million to $150 million range.

Traditional buyout firms don't usually invest in debt securities, something of no small concern to limited partners in PE funds. "It's a question of whether the activity is a logical extension of a manager's investment skills while adapting to current market conditions, or whether it's strategy drift.

"There's always a fine line between those two points," says Von Lehe.

For Sun Capital, Blechman argues, DIP lending isn't that much of a stretch, given its turnaround record. Its participation in DIP loans is "purely strategic," he says, a means toward ultimately achieving the best returns for LPs. The firm, whose current $6 billion fund is still largely uninvested, has a broad mandate to invest in a range of securities, including bridge loans.

Like a few other players, Sun has a loan-to-own approach, where it may offer DIP loans selectively to portfolio companies as well as companies it doesn't already own. Judging from its two recent experiences, one of its strategies is to go into prepackaged bankruptcy restructurings as the DIP sponsor, with hopes of delevering the business and eventually gaining equity or acquiring the bankrupt assets in a sale.

In the case of Fluid Routing Solutions, Sun agreed to provide as much as $12 million in DIP money as part of a Chapter 11 filing with the U.S. Bankruptcy Court for the District of Delaware in Wilmington. It also expected to be a stalking-horse bidder in the auction of the company's fuel-systems business. Two separate DIP loans paid off the $3.4 million in first-lien debt owed to senior lender Wells Fargo Foothill Inc. Other unsecured creditors may end up seeing some recovery eventually. Since Sun Capital was the sole bidder, the company canceled the scheduled auction, and the sale was approved March 24.

"Three of FRS' four plants are profitable, and the bankruptcy restructuring gave us flexibility to save about 900 jobs," says Blechman. "We wanted to support the company, and the only way to do it was through a DIP loan inside a Chapter 11 restructuring."

Sun acquired FRS in 2007 as a portion of Mark IV Industries Inc.'s Dayco Products Inc. division, which included six factories. The Rochester Hills, Mich., company manufactures power steering, radiator hoses and transmission oil cooler assemblies for automakers.

More recently, it offered Big 10 Tire Stores up to $27.9 million in DIP financing in preparation for an auction in which it also hopes to be a stalking-horse bidder. The DIP, consisting largely of a rollup of prepetition debt due Sun Capital, is coming from Sun Capital affiliate Sun BT Finance Holdings LLC. The Mobile, Ala., company suffered from the recession as well as steep commodity prices that it was largely unable to pass on to its customers.

Things aren't always as straightforward in bankruptcies, however. Courts aren't usually predisposed to grant DIP lenders prior lien position, so DIP loans are typically done consensually, lawyers say. "With specific prepackaged filings, you can at least see where you expect to come out in the plan, but in a Section 363 sale, someone else may come in and that can create uncertainty," says Goodwin Procter's Reilly.

Both LPs and their general partners have additional worries. In situations where there may be cross-fund investing -- when a PE firm invests in the same securities out of two distinct funds at different times, creating an anomaly -- there's an inherent conflict of interest. "The challenge for both the GP and LPs is to ensure that any conflicts of interest are being appropriately managed and that no LPs on either side are put at a disadvantage," Von Lehe says.

Having the right sort of expertise is another major concern. "It's a very niche market, and you really need to know what you're doing," says one debt expert. "You need to make sure you don't fall into traps, because there are definitely traps in there."