boltKey takeaways
- Private credit is lending to companies or against assets by non-bank investors, with loans negotiated directly and held rather than traded.
- Most returns come from contractual income: a floating base rate plus a spread, original issue discount and fees, offset by credit losses.
- Seniority, covenants and documentation matter as much as the stated yield; a higher coupon is often paying for weaker protection.
- Vehicles range from closed-end drawdown funds to BDCs and evergreen funds, each with different liquidity, leverage and reporting rules.
- Credit funds run on loan-level data: interest accruals, amortization, PIK, fees, amendments and covenant tests all flow into NAV and investor allocations.
Private credit is lending by non-bank investors (funds, insurers, business development companies and other institutions) directly to companies or against specific assets. The loans are negotiated privately and usually held until they are repaid, rather than syndicated and traded. Investors are paid mainly through contractual interest and fees, which makes private credit an income-oriented complement to private equity's growth-oriented returns.
This guide covers the main strategies, where returns come from, the vehicles managers use and what it takes to run a credit fund operationally.
Why private credit grew#
After the 2008 financial crisis, banks faced tighter capital requirements and pulled back from holding middle-market corporate loans. Non-bank lenders stepped in. Borrowers, often private equity–backed companies, came to value what private lenders offer: speed, certainty of execution, a single counterparty to negotiate with and flexible structures. Investors were attracted by floating-rate income, a premium for illiquidity and complexity, and lower volatility in reported values than traded credit.
Private credit is now a standard allocation for many institutions, and large managers run credit platforms alongside their equity funds.
The main strategies#
| Strategy | Position in capital structure | Typical borrower | Return profile |
|---|---|---|---|
| Senior direct lending | First lien, often unitranche | Sponsor-backed middle-market companies | Lower yield, priority on recovery |
| Mezzanine / junior capital | Second lien, subordinated debt, preferred | Companies needing capital beyond senior debt | Higher yield, often with PIK or equity kickers |
| Asset-based lending | Secured on receivables, inventory, equipment, or specific asset pools | Asset-heavy businesses, specialty finance | Return tied to collateral performance |
| Distressed and special situations | Varies | Stressed or restructuring companies | Discounted entry, event-driven |
| Venture debt | Senior secured, small hold sizes | VC-backed growth companies | Interest plus warrants |
| Real estate and infrastructure debt | Senior or mezzanine against property or projects | Asset owners and developers | Income secured by real assets |
Unitranche loans combine senior and subordinated debt into a single facility with one blended rate. Behind the scenes, lenders sometimes split it into first-out and last-out pieces through an agreement among lenders, which affects recovery priority.
Where the returns come from#
Credit returns are built from contractual pieces, and losses are the main way they go wrong. A simple framework:
Expected return ≈ base rate + spread + annualized fees/OID − expected credit losses − fund costs
Assume a fund makes a $50M senior loan at SOFR + 5.75% with 2 points of original issue discount, on a three-year expected life. With SOFR at 4.0%:
| Component | Annualized |
|---|---|
| Base rate (SOFR) | 4.00% |
| Spread | 5.75% |
| OID amortized (2 points ÷ 3 years) | ~0.67% |
| Gross yield | ~10.4% |
If the portfolio's expected annual loss rate (default probability × loss given default) is 0.5% and management fees and expenses take another 1.5%, the net unlevered return is roughly 8.4%. Many funds add fund-level borrowing to amplify that, which raises both return and risk.
Two points to note. First, floating rates mean income rises and falls with base rates, but higher rates also strain borrowers' interest coverage. Second, the stated coupon is only part of the picture. Covenants, call protection, collateral and the borrower's leverage determine how much of the yield is actually earned.
Structures and documentation that matter#
Experienced credit investors spend as much time on documents as on the business. Key elements include:
- Seniority and security: first-lien claims on all assets versus subordinated or unsecured claims.
- Financial covenants: maintenance tests such as maximum leverage or minimum interest coverage, tested quarterly. Middle-market loans more often keep maintenance covenants; large syndicated loans are often covenant-lite.
- Payment-in-kind (PIK): interest added to principal instead of paid in cash. It boosts reported income while deferring cash and can signal stress if introduced mid-life.
- Call protection and prepayment fees: compensate lenders when borrowers refinance early.
- Amendment and waiver terms: who must consent to changes, and on what terms.
Fund vehicles for private credit#
| Vehicle | Liquidity for investors | Leverage | Notes |
|---|---|---|---|
| Closed-end drawdown fund | None until distributions | Moderate, often a subscription line plus asset-level facility | Familiar LP structure with waterfall and carry |
| Evergreen / open-ended fund | Periodic subscriptions and redemptions, often with gates | Varies | Income reinvested; requires regular NAV |
| Business development company (BDC) | Listed BDCs trade daily; non-traded BDCs offer periodic repurchases | Limited by 1940 Act asset coverage rules | Must invest mainly in eligible U.S. companies; typically elects RIC tax treatment and distributes most income |
| Separately managed account | Negotiated | Negotiated | For large institutions wanting custom terms |
Evergreen structures have become popular for credit because income-producing assets fit continuous subscriptions. They bring their own complexity around NAV frequency, liquidity management and fee crystallization. See evergreen funds.
Risks investors should understand#
- Credit risk: defaults and losses, which tend to cluster in downturns.
- Valuation lag: loans are marked by models and comparable spreads, not trading prices, so reported values may move more slowly than economic reality.
- Concentration: exposure to a sector, a sponsor or a small number of borrowers.
- Liquidity mismatch: in evergreen vehicles, redemption requests may exceed what the portfolio can provide.
- Leverage: fund-level borrowing magnifies losses as well as income.
- Documentation drift: looser terms in competitive markets reduce protection later.
Diligence on a credit manager should look at loss history through a cycle, workout capability, how often loans were amended or moved to PIK, and how portfolio valuation is done.
Questions to ask a credit manager#
When evaluating a private credit manager, a short list of questions reveals a lot:
- How did the portfolio perform through the last period of stress, and what share of loans were amended, extended or moved to PIK?
- What is the realized loss rate across all vintages, not just the current fund?
- Who leads workouts, and have they taken control of a borrower before?
- How concentrated is the book by borrower, sponsor and sector?
- How are loans valued each quarter, and who independently reviews the marks?
- How is fund-level leverage sized, and what are the facility's margin and eligibility terms?
Answers to these questions belong in the same due diligence file as returns data, because in credit the downside matters more than the headline yield.
Running a credit fund: the operational load#
Credit funds are more data-intensive than equity funds of similar size. An equity fund might record a handful of transactions per holding each year; a credit fund records interest, fees and principal movements for every loan, often monthly. Operations teams need to handle:
- Interest accrual on floating rates, with each period's base-rate reset, day-count convention and any rate floors.
- OID and fee amortization under the effective interest method.
- PIK capitalization and its effect on both income and principal.
- Amortization schedules, prepayments and delayed-draw tranches.
- Non-accrual status when a loan stops paying, with reversal of accrued income.
- Covenant monitoring from borrower compliance certificates.
- Allocation of income to investors, often with different fee classes or tax profiles.
Investors in credit funds also expect regular income distributions, clear reporting of yield and non-accruals and tax reporting that reflects interest, OID and other income correctly. Strong portfolio monitoring is what turns borrower data into early warning rather than late surprises.
How Privatis helps#
Privatis supports credit managers with a double-entry fund general ledger and period close, NAV and portfolio valuations, distribution processing with waterfall calculations and management fee calculation. Investors see capital account statements, reports and K-1s in the LP portal, and an audit trail captures every change behind the numbers.