Is there life after leverage for private equity? The global financial system is struggling to work its way out of disaster: banks are flat on their backs, equity markets have plummeted, and a business culture built on leveraged portfolios has come unhinged. The future of private equity is one of the more intriguing questions for corporate finance and corporate governance alike.

It may seem hard to be sanguine about the sector’s long-term prospects. With returns under pressure, private-equity firms will struggle to perform. The megabuyouts (deals valued at more than €5 billion) that absorbed so much of the sector’s capital since 2004 are nowhere to be found. Some limited partners—in particular, sovereign-wealth funds—have shown a willingness to bypass private-equity firms and strike out on their own. With an estimated $470 billion in committed but unused funds, the sector faces an enormous challenge just finding ways to invest. Finally, its portfolio companies, with their high debt levels, may become financially distressed and default in the event of only small downturns in sales and EBITDA. Recent bankruptcies of several private equity–backed companies hint at how dark the future may be.

Yet the prognosis isn’t entirely bleak. In our experience, the sector’s strengths have come not from its use of leverage but from its ability to marshal resources, both human and financial; its strong incentives to adapt quickly; and its active ownership. Opportunities do exist: megadeals may have vanished, but not medium-sized or all-equity deals. Moreover, private-equity firms are well poised to stand in as a new class of shareholder in the overturned public-equity market, in developing economies, and in financial institutions. Despite the current difficulties, it bears remembering that the best private-equity firms have persistently outperformed both their private-equity counterparts and the public-equity markets, in good times and bad, over the past two decades. The winners will be firms with the wits to adapt to a much harsher environment.