What is private credit? A guide to direct lending

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Private credit can finance a range of business needs, from company growth to real estate development.

© Maskot—DigitalVision/Getty Images, © kolderal—Moment/Getty Images; Photo composite Encyclopædia Britannica, Inc.

When investors look to yield-bearing assets in the alternative debt universe, it’s usually to pursue higher yields compared with traditional debt and fixed-income securities, and to achieve a deeper level of diversification beyond conventional stocks and bonds.

One alternative investment that’s grown considerably over the last few decades is private credit. The size of this market stood at $1.5 trillion in 2024 and, by some estimates, is expected to nearly double by 2028.

Private credit can help companies raise money in less time and with more certainty than getting a loan from a bank or issuing bonds that trade on the public markets. But there are risks to this type of debt financing.

If you haven’t heard of private credit, it may be because it’s utilized mainly by professional investors—although retail investors can still get limited exposure to this market.

Private credit is a type of private debt, an umbrella term for loans issued by nonbank and nonpublic entities to private businesses or individuals, rather than through the commercial banking system.

Private debt can range from smaller unsecured loans, as is the case with peer-to-peer (P2P) lending, to larger and mostly secured loans issued by financing institutions, also known as private credit.

Private credit refers to loans issued by a private institution and extended to privately held companies. Unlike some forms of private debt—P2P lending, for example—most of these loans are secured. And unlike other forms of private debt, private credit loans typically have floating interest rates.

Suppose a company in need of financing chooses not to borrow money from a bank nor to issue bonds that can be traded in a public market. One alternative is for the business to seek funding from a private credit fund. In this scenario, the private credit fund sets the loan conditions and lends capital to the company.

Private credit funds are specialized operations within larger financial institutions. Examples include private equity firms and investment banks like Blackstone, Apollo Global Management, Carlyle Group, Morgan Stanley, and Goldman Sachs. You may have heard of a few of these, but they’re not all household names for retail investors.

Private credit includes several forms of lending with different purposes and levels of risk.

Direct lending provides credit to companies without investment-grade credit ratings. Despite this status, direct lending may be the least risky of all lending strategies, as it typically holds priority (“senior”) status (meaning it gets repaid first before all other debts). In exchange for the lower risk, direct lending generally offers lower yields than riskier forms of private credit.

When a company that’s exhausted its senior debt capacity still needs to raise capital to finance growth, corporate acquisitions, or other needs, it may resort to mezzanine debt. This type of financing falls under the category of subordinated, or junior, debt, meaning it’s further back in the line of the repayment hierarchy.

Mezzanine debt is typically unsecured as well as subordinated, making it riskier than senior secured debt. In exchange for the greater risk, it generally offers higher yields.

When a company in financial hardship seeks capital to restructure its balance sheet and improve its financial position, it may turn to investors willing to finance its turnaround efforts. Distressed debt is highly specialized, and opportunities for such investments typically coincide with tighter credit conditions and periods of economic weakness or contraction. These loans are in the higher-risk and high-yield spectrum of the private credit market.

Some companies may need capital to undergo structural changes that fall outside the realm of everyday business activities. These are also called nontraditional capital events. They can include corporate restructuring, merger and acquisition (M&A) sales, spin-offs, divestitures, bankruptcy processes, and other activities.

Private credit can offer higher yields than traditional fixed-income investments, but those potential returns come with risks. Among the most important are credit risk, liquidity risk, and valuation risk.

A borrower may run into financial trouble and be unable to make interest payments or repay a loan. Although many private credit loans are secured by assets, lenders can still lose money if a borrower defaults. The risk varies depending on the borrower and the type of private credit. Distressed and subordinated debt, for example, generally carry greater credit risk than senior secured loans.

Unlike publicly traded bonds, private credit loans generally don’t trade on established secondary markets, making them difficult to sell, particularly during periods of financial stress.

The lack of an active market also makes private credit investments more difficult to value. Without readily available market prices, funds may estimate fair value using information about the borrower as well as assumptions about credit spreads, discount rates, and comparable transactions. Changes in those assumptions can significantly affect the reported value of an investment.

As the names suggest, private credit and private equity both invest in private businesses—those that aren’t publicly traded. One of the main differences is how you earn returns:

Another difference is risk. If a company goes bankrupt, private creditors generally have more protections and repayment priority compared to shareholders, who have an ownership stake in the company.

Accredited investors (those with a high net worth or high annual income) and nonaccredited (retail) investors have different paths to investing in private credit. If you’re interested in this market, consider these suggestions.

Private credit can offer higher yields and diversification beyond traditional stocks and bonds, but those potential benefits come with added credit, liquidity, and valuation risks. The risks can vary considerably depending on the borrower, the type of loan, and how the investment is structured.

This article is intended for educational purposes only and not as an endorsement of a particular financial strategy or company.