Private Credit

What is private credit/private debt?

In private credit, also known as private debt, a company raises capital from an individual, non-bank source. Private credit is often appealing to borrowers who can’t access financing through more traditional means, like a bank or bond markets, or for borrowers looking for a speedier financing option.

Private Credit vs Private Debt

Private debt is a term used interchangably with private credit, where a company may seek investment directly from an individual, non-bank source.

Private Credit vs Private Equity

In private credit, lenders will not be stakeholders in the company in exchange for lending.
The difference between private equity and debt investment is the investment into private companies in exchange for a stake in the company in private equity deals. Private equity firms manage private equity deals — collecting money from individuals or companies then investing that money into a company showing promise of high returns. The goal of private equity investments can vary — investors may be interested in targeting a new, promising company or a struggling one. The goal of private equity, ultimately, is to decide which company to invest in and then provide guidance to make the company as profitable as possible.

Private Debt

While private debt, or private credit, is issued by a private, non-bank company or individual, public debt is issued by governments or public institutions. Public debt is used to develop public infrastructure and provide public services and is typically issues through bonds that members of the public can buy.

In the private credit/private debt market, borrowers tend to be small to middle-market companies, ranging from $3 million-$100 million in EBITDA. In this asset class, borrowers work more directly with lenders than in public credit markets, which allows for quicker turnaround and a clearer understanding of pricing. Asset managers are critical to the private debt market due to their lending platforms. Many asset managers may operate a variety of lending platforms, including private debt funds and middle-market CLOs, among others.

History and evolution of private credit/debt

One major catalyst in the growth of private credit markets was the Global Financial Crisis in 2007 and 2008. With new regulations by the government and decreased lending by banks in the U.S. corporate leveraged loan market, there was a gap in credit availability for middle market companies. 

This gave way for a growth in private credit, or private debt. Non-bank lenders stepped in to provide capital to middle market companies. Due to the often high returns on private loans, the asset class, which has grown exponentially in recent years, is attractive for lenders, especially those looking to diversify their investment portfolios.

Depending on the level of risk an investor is willing to make, there are different private credit (also called private debt) strategies they may choose to follow.

Capital Preservation

Considered to be a less risky strategy, in capital preservation the goal is just that: to minimize losses. This, however, often leads to lower returns than would be seen with a riskier strategy. Capital preservation involves senior lending and mezzanine debt.
Senior lending is this least risky lending option. In this strategy, the lender is guaranteed to be paid first in the case that the borrower files for bankruptcy. Because senior lending is not as risky as other private credit strategies, lenders may receive lower interest rates.
Mezzanine debt involves private credit along with private equity, meaning the lender provides capital to the borrower along with taking a stake in the company.

Return-Maximizing

Return-maximizing strategies focus on a higher return for the lender, but often come with higher risks. Return-maximizing strategies include distressed credit, small business credit and capital appreciation.
In distressed credit, lender(s) provide capital to companies in poor financial condition, with the goal being that the company either turns its performance around or files for bankruptcy. In either scenario, the lender will receive a payment. This strategy, however, can come with more risks and potential hostile relationships with the company.
Lenders may also provide capital for smaller companies or small businesses that are willing to pay a higher interest rate. Although this can be riskier than lending to larger companies, it allows a lender to invest in a variety of businesses to ensure returns, even if some of the small businesses fail.
Capital appreciation is when a lender provides credit in exchange for equity in the company. This strategy may pose risks depending on the performance of the company.

Private credit can be extremely attractive to investors, especially those looking to diversify their portfolios, due to its high returns.

Investing in private credit is not without its risks, however. Before investing in private credit, be aware that a company may have a weak credit profile if they’re seeking private credit. The company may also have potential for defaulting on a loan.

Private Credit Investors

Most private credit investors — more than 70% — are institutional investors, or entities investing on behalf of an individual. Private credit investors typically work with a private credit fund to oversee the lending and help decide which companies to invest in.

Private credit investing vs private equity investing

Investing in private credit is typically lower risk than investing in private equity.
Because private equity involves taking an ownership stake and has a much longer investment cycle, it is often higher risk — and can lead to higher returns — than private credit.
Private credit investing, on the other hand, is simply the act of lending money to a company or individual. In private credit, there is a set repayment schedule, and much of the return is earned through prinicpal and interest payments.

A private credit fund is a collection of capital used to invest private credit into companies or individuals. In a private credit fund, investors typically pool their capital and allow an investment manager to make decisions for the fund.

Private credit funds are often exclusively available to investors who meet a number of qualifications — approved investors are typically individuals or institutional investors with a high net worth.