What is private credit, and why has it grown so quickly? Private credit is lending to businesses that happens outside traditional banks and public bond markets. Once mostly used by large institutions, it is now discussed regularly among private investors looking beyond shares and bonds. This guide explains what private credit is, how it works, the main types you are likely to see and the risks to understand first.
What Is Private Credit?
Private credit, sometimes called private debt or direct lending, describes loans made to companies by non-bank lenders. Rather than borrowing from a high street bank or issuing bonds on a stock exchange, a business agrees a loan directly with a specialist lender or fund. The terms are negotiated privately between the two sides.
For the investor, the return usually comes from the interest paid on these loans, rather than from a share in the company’s profits or growth. That is why private credit is often grouped with fixed income, even though it behaves quite differently from government or listed corporate bonds.
Why Has Private Credit Grown?
Since the 2008 financial crisis, tighter rules on banks have made them more cautious about lending to small and medium-sized businesses, particularly for complex or non-standard deals. Private lenders have stepped in to fill much of that gap.
At the same time, investors have looked for sources of income that do not rely only on stock market performance. Private credit can offer that, which has led to strong growth in the market over the past decade. Major asset managers around the world have expanded their private credit businesses to meet demand.
How Does Private Credit Work?
Most private credit investments follow a similar pattern. A lender, often a specialist fund, agrees to lend money to a company for a set term. The loan sets out the interest rate, the repayment schedule and any security, such as a charge over the company’s assets. It may also include covenants, which are conditions the borrower must keep to, such as staying within certain financial limits.
Many private credit loans pay a floating rate of interest linked to a benchmark rate, so the income can rise or fall with interest rates. Investors usually gain access through a fund, a bond or a note issued by the lender, rather than by lending to a business directly themselves.
What Types of Private Credit Are There?
Private credit covers a wide range of lending. Some of the most common types include:
- Direct lending: loans to established small and mid-sized companies, often to fund growth or acquisitions.
- Asset-backed lending: loans secured against specific assets such as property, equipment or invoices. Our guide to structured finance covers this in more detail.
- Real estate debt: lending to fund property development or investment, including bridging loans.
- Mezzanine finance: lending that ranks behind senior debt but ahead of shareholders, which usually means a higher rate to reflect the higher risk.
- Distressed and special situations: lending to companies going through difficulties or restructuring.
What Are the Risks of Private Credit?
Private credit can provide a regular income, but it is not without risk. The main points to understand include:
- Default risk: if a borrower cannot repay, investors may lose some or all of their money, even where security is in place.
- Liquidity risk: private loans cannot easily be sold, so your money is usually tied up for the full term.
- Valuation risk: because private loans are not traded on an exchange, their value is estimated rather than set by a market price.
- Economic risk: in a downturn, more borrowers may struggle to repay at the same time.
- Limited protection: many private credit investments are not covered by the Financial Services Compensation Scheme (FSCS).
What Should You Check Before Considering Private Credit?
Before looking further into any private credit opportunity, it is worth checking:
- Who the borrowers are, and what the money is being used for
- Whether loans are secured, what the security is and where it ranks
- How the lender or fund manager assesses borrowers, and its track record
- How often interest is paid, and what happens if a borrower falls behind
- How long your money will be tied up, and whether there is any way to exit early
- How private credit fits alongside the rest of your portfolio
Investors considering private credit are always encouraged to seek independent financial advice appropriate to their own circumstances, and to read the full terms before committing any capital.
About New Capital Link
New Capital Link works with experienced and high net worth investors, helping them understand the range of alternative investment opportunities available to them. Please read our risk warning before considering any investment.
If you would like to learn more about how private credit works, get in touch with our team for an informal discussion.
