Kohlberg & Co. wants to give investors a way into an expanding but risky area of the debt market.

The private equity company filed Friday to raise $225 million by selling the public shares in a closed-end investment fund. Kohlberg's Kohlberg Capital affiliate will use proceeds to acquire a $200 million fund made up of first- and second-lien loans.

Second-lien loans give less creditworthy companies better access to capital. Lenders get higher interest payments but also a greater risk of default. Loan issuance has risen sharply in recent years, according to industry data.

"Issues in the second-lien loan market have been recently reached unprecedented levels," says Faris Khan, editor-in-charge of syndicated loans at the Loan Pricing Corporation. "Second-lien loans are relatively new, but overall credit markets have been extremely bullish for close to 18 months."

As the market for second-lien loans heats up, profiting from closed-end fund deals becomes easier.

"They are taking an illiquid asset, like these loans, and people can effectively own small portion of the loan without having to deal with the illiquidity," says Matthew Rhodes-Kropf, finance professor at Columbia Business School. "As liquidity picks up, shares of a fund will trade higher than the underlying value of the fund. So someone like Kohlberg gets more likely to do this deal in a market that is becoming more liquid."

Kohlberg & Co. was founded in 1987 by Jerome Kohlberg, a founder of the famed private equity firm Kohlberg Kravis & Roberts. He founded his firm, now run by his son James, just before KKR did its buyout of RJR Nabisco. That transaction remains the largest LBO in history.

While KKR continues to hunt big game, such as hospital operator HCA ( HCA), Kohlberg & Co. specializes in buying companies valued at between $100 million and $500 million. It has invested in three companies since 2004, and its most recent fund has $800 million under management.

Kohlberg Capital will use the cash from the IPO to buy a part of Katonah Debt Advisors, an asset manager owned by Kohlberg & Co. that specializes in managing collateralized debt funds.

Lehman Brothers ( LEH), Merrill Lynch ( MER), BMO Capital Markets and Bank of America ( BAC) will underwrite the deal.

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