Private Credit

Private credit simply means lending money to companies or projects without using a bank or the public bond markets. In exchange for providing capital outside the traditional system, the lender (the fund, and by extension, you) expects a higher yield.

The yield is the marketing. The risk is in the security, the covenants, and the sponsor’s ability to recover capital when a borrower stops paying.

Where You Sit in the Capital Stack

Every company has a capital stack — an order in which people get paid back in a bankruptcy or liquidation. Where a private credit fund lends within that stack dictates its risk profile.

• Senior Secured (First Lien): The safest position. The loan is backed by specific assets (inventory, equipment, real estate). If the company fails, the senior lender takes the assets, sells them, and gets paid first.
• Unitranche: A single loan that blends senior and subordinated debt into one rate. Common in middle-market lending.
• Mezzanine / Subordinated: Sits below senior debt but above equity. Unsecured, higher yield, and vulnerable to total loss if a liquidation doesn’t generate enough cash to clear the senior lenders first.

The Rule: If a fund advertises a double-digit yield in a normal interest rate environment, it is taking risk. It is either lending lower in the capital stack, lending to distressed borrowers, or using leverage at the fund level to juice the returns.

Asset-Backed vs. Cash-Flow Lending

How does the fund expect to get paid back?

Asset-backed lending relies on collateral. The fund lends against real estate, heavy equipment, or receivables. The diligence focuses on the liquidation value of the asset. If the borrower defaults, the fund forecloses, sells the asset, and recovers the principal.

Cash-flow lending relies on the borrower’s ongoing business operations (EBITDA). There is no hard asset to seize if things go wrong; the fund is betting the company will keep generating enough cash to service the debt. This requires much tighter covenants (financial rules the borrower must follow) and closer monitoring.

What Happens in a Default

Lending is easy. Recovering money from a hostile, bankrupt borrower is hard. A private credit fund’s true value is its workout capability — its ability to step in, take control of collateral, restructure the debt, or take over the company.

When evaluating a sponsor, ask about their historical loss rate, not just their default rate. A default just means a missed payment or breached covenant. The loss rate measures how much principal was permanently lost after the workout process finished. A good sponsor will have defaults; they should have very few permanent losses.

The Liquidity Mismatch

Private credit loans are illiquid. They cannot be sold easily on a secondary market. If a fund makes a 5-year loan to a middle-market company, that capital is locked up for 5 years.

If you invest in a closed-end fund, your capital is locked up alongside the loans. The fund will distribute interest as it’s paid, and return principal as loans mature.

If you invest in an interval fund or a BDC (Business Development Company) that offers quarterly liquidity, be careful. If the fund’s underlying loans are illiquid, but the fund allows investors to redeem shares, it has a liquidity mismatch. In a panic, if too many investors ask for their money back at once, the fund cannot sell the loans fast enough to pay them. The fund will “gate” — legally suspend redemptions — and your liquid investment becomes instantly illiquid.

The Tax Drag

Private credit generates interest income. For U.S. taxpayers, interest is generally taxed at ordinary income rates (up to 37% federally), not the preferential long-term capital gains rate. A 10% yield in a private credit fund nets out significantly lower after tax than a 10% return in an equity fund. Consider placement in tax-advantaged accounts if the structure permits it.