What is private debt? The ultimate guide (2024)

Did you know that private debt accounts for a substantial piece of the private markets—16.6% of total assets under management (AUM), as of September 30, 2023, according to PitchBook? In fact, most private middle market companies have at least some debt, particularly in private credit. 

What is private debt?

Private debt includes any debt held by or extended to privately-held companies. It comes in many forms, including loans and bonds, but commonly involves private credit, when other asset managers make loans to private companies. 

A variety of general partner (GP) credit investors manage private credit or other debt funds. These alternative lenders manage investment strategies that include direct lending, distressed debt, mezzanine, real estate, infrastructure and special situations funds, among others. In addition to paying back the full sum of the loan in the future, the company must also pay interest to the lending institution. 

Private debt funds come in different shapes and sizes. For example, some private debt fund structures provide capital to sponsor-backed borrowers, others fund real estate development projects, and some invest entirely in the debt of distressed companies.

Private credit vs private debt

You will sometimes see private debt and private credit used interchangeably. However, an important distinction is that private credit is just one type of private debt.

At PitchBook, we define private credit, or direct lending, as directly originated loans to corporate borrowers that are not broadly syndicated. They are typically unrated, and borrowers tend to be small to midsized companies. However, in recent years, larger borrowers have issued this type of financing as well.

Private credit is typically provided by a non-bank lender, or a small group of lenders in a club deal. That said, there are some cases where a bank is one of the lenders alongside an alternative lender or lenders. As mentioned above, this often includes general partners.

Why invest in private debt?

Investor demand for debt funds is on the rise. Companies increasingly turned to private debt in recent years at times when financial market volatility made public debt markets harder to access. Depending on interest rates, regulations, business cycles and other factors, investors may view private debt as a relatively low-risk approach to private equity or the diversification of their assets.

How PitchBook categorizes private debt

PitchBook takes a hybrid approach to private debt  fund categorization, considering seniority in the capital structure, risk/return profile and industry exposure. You can explore any or all of the following categories in more detail on the PitchBook Platform.

Types of private credit and debt

The private debt strategies below are in ascending order of relative risk/return characteristics:

Direct lending

Senior loans made to mid-market companies without an intermediary. Often financed by alternative lenders, they may include revolving credit lines and second lien loans. Unitranche loans, which combine different tranches of debt into a single facility, have become more common.

Infrastructure debt

Debt used for infrastructure development and investment in existing assets, generally with longer terms (30+ years) because of the extended useful life of the assets.

Mezzanine debt

Subordinated debt, generally with features like preferred equity, like warrants—which increase the value of the debt. Mezzanine debt is often used in leveraged buyouts (LBOs).

Real estate debt

The most common real estate debt strategy is direct lending for real estate acquisitions. May include the buying and selling of securitized real estate loans in the secondary market. Risk profiles vary based on the underlying assets.

Special situations

Debt made with the intent of gaining control of a company—generally, one in financial distress. Special situations can include trading in the secondary market, direct origination, or distressed debt where the manager believes price dislocation is present.

Distressed debt

Distressed debt is rated below investment grade or are non-performing loans and bonds. It differs from special situations in that it generally involves the purchase of securities in the secondary market, rather than new origination of debt or structured equity.

Venture debt

Debt financing extended to companies with venture capital backing. For entrepreneurs, venture debt—also called venture lending—serves to extend the runway to exit without further diluting ownership. Venture debt is a type of short- to medium-term debt financing provided to venture-backed companies by specialized banks or non-bank lenders to fund growth and capital expenses.

Benefits of private debt

Benefits for borrowers

Wondering why a company might choose to finance with debt? In a few words: It’s considered more cost-efficient—more specifically:

• The interest payments that a borrower owes a lender typically has a fixed timeframe and will conclude when the debt matures, while equity holders have ownership of a company’s owners in perpetuity
• Interest expenses can be used as tax-write-offs—this is referred to as the tax shield

Benefits for investors

Private debt investments can be appealing to investors looking to diversify their portfolios and adjust their exposure to certain parts of the economy. In a high-interest rate environment, there is also the potential for higher returns for floating rate notes. 

Growth of the private credit market in recent years

When regulations were put on banks after the Global Financial Crisis (GFC), a new lending market formed for non-bank entities. With high-yielding opportunities in public markets being few and far between, investors explored new strategies. Private credit funds, serving as direct lenders to middle-market companies and sources of debt financing for leveraged buyouts (LBOs), promised to provide the higher yield that investors wanted.

As such, we are now seeing more LBO funding via direct lending versus broadly syndicated loans.

But private debt fundraising totaled $109.5 billion in 2008, according to PitchBook, indicating that there was plenty of interest in direct loans even before the GFC crash. In fact, industry titans like Apollo and Oaktree have been raising private credit vehicles since the 1990s. However, the industry was less developed and more concentrated in the years leading up to the crisis, only gaining widespread recognition in the last decade.

Milestones in the post-global financial crisis regulatory environment—including the Dodd-Frank Wall Street Reform and Consumer Protection Act, Basel III and the US’ Guidance on Leveraged Lending—cultivated demand for financing opportunities from non-bank lenders. As reported in our recent Private Credit & Middle Market Weekly Wrap, the primary private credit market is now expected to double in size by 2028, to $3.5 trillion (source: Blackrock).

Useful debt terms to know

Private debt vs private equity

Debt and equity are two broad categories that make up the capital markets, and both are important components of financing companies—both public and private. A company’s capital structure will contain a mix of equity and debt to finance their operations.

With private debt financing, ownership is retained by the company. However, they must sign a contract with the debt investor (or lender). As the borrower, the company is legally required to pay the lender. There’s no such guarantee of a return for equity investors. Because debt investors are more senior investors in the capital stack, they get paid out first in a workout. For these reasons, debt investing is typically seen as lower risk, lower return, and more stable from a cash flow perspective than equity investing.

In equity financing, the investor receives partial ownership in the company they are providing financing to, and therefore, a claim to all future earnings. These claims are rewarded as dividends paid out to the equity investor or stockholder. Equity investing is lower in priority in case of a liquidation event, and it has the highest risk and highest cost.

Debt facility

A debt facility is financial nomenclature for the type of loan, also known in PitchBook as “debt type.” Not all loans are created equal, and each debt facility has its own distinctive rules about how it’s paid back, how interest is calculated, and how senior or junior it is in a liquidation event.

Maturity date

The maturity date is the final payment of the principal and any remaining interest payments owed back to the lender. When discussing debt instruments you may hear the term yield to maturity. This is an aggregated dollar figure used to calculate what the remaining value of the loan is by adding up the future principal and interest payments from the current date to the maturity date if the loan is paid in full.

Principal and interest

The principal is the amount of money transferred from the lender to the borrower. The interest is what the lender is charging the borrower for the use of the lender’s money. Interest is typically benchmarked against the Secured Overnight Financing Rate (SOFR), as you will see in the PitchBook Platform.

Tenor

Tenor is the debt term for the “lifetime of the loan.” It is the length of time from when the borrower receives the debt financing from the lender to the maturity date of that facility. From a technical perspective, tenor and maturity have distinct meanings. Whereas tenor refers to the length of time remaining in a contract, maturity refers to the initial length of the agreement upon its inception.

Note that PitchBook’s deep database of debt information encompasses the above criteria within our Debt & Lenders advanced search. Access granular data on the latest deals and precedent transactions, so you can operate with confidence.

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