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24 March 2025
Private Credit vs Private Equity: What is the Difference?
When it comes to investing in private markets, most investors look for investment strategies that offer good interest rates and capital structure. Whether you belong to the class of private credit investors or private equity investors, this article is your guide towards understanding the concept of debt and equity for predictable returns.
Join us as we uncover the major differences between private equity and private credit strategies, shedding more light on how investors in private credit generate returns. We will also look at private equity investing and the potential for higher returns.
As an investor looking to utilize the various credit instruments like banks, this article is a must-read for using private credit opportunities to gain predictable and stable returns in the market.
What is Private Credit?
Private credit involves making loans to businesses and individuals through private credit assets. It can also be called the private debt market, and this type of investment is done when investors make loans to businesses with large amounts of capital in a private setting without using public credit markets. Private credit continues to grow because investors earn returns through interest.
Private credit came into play during the financial crisis in 2008 when financial institutions were heavily sanctioned and needed regulatory requirements, as mutual funds, leading to a gap that was covered by private credit funds. Private investments have exceeded $2 trillion in today's world and can be seen as an alternative investment for gaining private loans.
Key Characteristics of Private Credit Investment
Private credit firms have offered private capital directly to borrowers without using the public market. Private credit carries the following features:
1. Illiquidity: Businesses seeking private credit can get it privately without using public exchanges. Investments are not easily exited or sold between the parties
2. Higher Yields: Private credit has higher returns than private equity funds. This helps to compensate for the high liquidity and risk, making it an ideal choice for yield investors who want low interest rates
3. Customized Structures: The loan market for private credit is customized to meet the special needs of borrowers. They are made to have flexible conditions like amortization schedules and covenants than conventional loans from private banks.
4. Private Negotiations: The conditions of loans can be directly negotiated between the borrower and lenders, giving rise to more control over collateral, risk handling, and covenants.
5. Focus on Middle-Market Companies: Most credit loans are given to small businesses with no access to capital markets, giving rise to a potentially high-growth market that is underserved.
6. Secured and Unsecured Loans: Private credit can be unsecured or secured with collateral. This can vary in return and risk profile, with secured loans providing more safety when borrowers default.
7. Low Correlation with Public Markets: Private credit is not influenced by the volatility in public markets, and it adds diversification to the investment portfolio of investors.
8. Covenant Protections: These are financial performance metrics added to protect the lender, and they lower the chances of financial mismanagement or default.
9. Longer Investment Horizons: The investment time usually lasts for 5 to 10 years and is perfect for investors who want less liquidity and long-term capital.
10. Due Diligence Intensive: Private credit demands risk assessment, deep analysis of credit, and borrower scrutiny. Furthermore, an active management of the portfolio and strong knowledge are needed for successful investing.
What is Private Equity?
Private equity involves taking ownership stakes in private companies or purchasing public companies to restructure operations and delist them. Investors in the private equity market get ownership stakes and can make a profit from exits like a sale or an IPO or through value creation.
PE companies finance acquisitions through leveraged buyouts (LBOs). They have an active role in running the company to improve performance and valuation. The main aim of equity holdings is for the appreciation of capital over time.
Key Characteristics of Private Equity
1. Illiquidity: PE investments cannot be traded or sold because they are long-term. People who venture into this investment must provide capital for 7 to 10 years.
2. Long-Term Investment Horizon: The long-term horizon of this investment creates room for the business to grow and add value. It is not the right choice for short-term investors who want fast liquidity.
3. Active Ownership and Management: Unlike the returns for private credit, companies in private equity have an active role, like operational improvements, guidance, and leadership in portfolio management to boost value.
4. High Return Potential: The target of private equity is major capital appreciation via restructuring, business growth, and IPO. Although they come with a higher risk, they can provide higher profits than public equities
5. Use of Leverage (LBOs): Several PE firms use debt to finance acquisitions like leveraged buyouts (LBOs) to increase risks and returns in market downturns.
6. Diversification Across Sectors and Strategies: A private equity firm has different strategies like venture capital, growth equity, buyouts, and distressed assets. This helps to provide exposure to several levels of risk profiles and company growth for potential returns.
7. Focus on Value Creation: The aim is to increase company operations through cost lowering, expansion, or innovation. The returns largely depend on market trends and operational movements.
8. Capital Commitment and Drawdowns: Investors are made to provide upfront capital, which can be used over time, requiring understanding of capital deployment schedules and planning.
9. Limited Regulatory Oversight: The investments in private equity are subject to fewer laws than public markets, creating room for flexibility and risk evaluation
10. Exits via IPOs, M&A, or Secondary Sales: Exit investment strategies can be achieved through mergers, secondary buyouts, or Initial Public Offerings (IPOs). Keep in mind that the success and timing of these exits largely affect returns.
Differences Between Private Credit and Private Equity
| Feature | Private Credit | Private Equity |
|---|---|---|
| Type | Debt (loan) | Equity (ownership stake) |
| Return Profile | Predictable income via interest | Capital appreciation over time |
| Liquidity | Moderate (5–7 year lockups) | Low (7–10 year lockups) |
| Risk Hierarchy | Senior creditor (paid first) | Subordinate equity (paid last) |
| Involvement Level | Passive | Active management, operational influence |
| Ideal For | Income-focused investors | Growth-oriented investors |
Pros and Cons of Private Equity and Private Credit
Pros of Private Credit Investing
- There is a steady flow of income
- Less volatile when compared to equity
- Higher yield than investment-grade or government bonds.
Cons of Private Credit
- Long periods of lock-up and illiquidity
- Higher risk of default during economic downturns
- There is limited transparency of public data.
Pros of Private Equity
- Potential for making high returns
- Active control to increase the performance of a business
- Diversification beyond public markets.
Cons of Private Equity
- Illiquidity and a very long-time horizon
- High performance and management fees.
- Higher chances of capital loss.
Choosing Between Private Credit and Private Equity
| Feature | Private Credit | Private Equity |
| Return Potential | Average (6 to 12%) | High (15 to 25%) |
| Risk | Lower | Higher |
| Liquidity | Medium | Low |
| Active Management | Passive | Active |
| Potential | Income | Growth |
| Perfect | Income investors | Growth investors |
Private Credit is perfect for investors who want steady flow of income, pension funds, and family offices. It can also be used by risk-averse investors who are looking for senior debt exposure.
Private Equity is perfect for companies and individuals with high net worth. It can also be used by investors who want long time horizons and aggressive growth of asset class.
Industry Trends & Regulation for Investors
The industry of credit and equity continues to grow exponentially, creating opportunities for private credit to rise. However, private credit may be implemented by PE firms to create hybrid structures that have greater flexibility. Regulators in private credit markets are warning of systemic risk and watching the market closely as risk assessment, transparency, and standardization continues to grow.
YouTube Video Resources to learn more about private credit and private equity investments:
Private Credit vs Private Equity Explained A simplified breakdown of both concepts, great for beginners.
Why Private Debt is Better Than Private Equity Dr. Adam Gower discusses why income-focused investors may favor private credit.
Conclusion
Both private credit and private equity offer compelling opportunities for those seeking to diversify their investment portfolios. Private credit provides a more stable income stream and prioritizes risk mitigation, making it suitable for conservative investors. In contrast, private equity allows for active value creation and potentially higher returns, but it demands a greater risk appetite and longer commitment.
Understanding your own financial goals, risk tolerance, and investment horizon is key to choosing between the two. Whichever path you choose, both assets can play a strategic role in a well-diversified portfolio.
You can also check out this article on portfolio rebalancing to learn how often you should rebalance your portfolio as an investor.
FAQs
1. Who can invest in private credit or private equity?
Mostly accredited investors or institutions. Some retail investors can access these via funds or ETFs.
2. What are the typical returns?
Private credit offers 8–14% IRR on average. Private equity may return 15%+, but it's more volatile and illiquid.
3. How long is capital locked in?
Private credit typically requires 5–7 years. Private equity often locks capital for 7–10 years or more.
4. Which is safer?
Private credit is generally safer due to its senior claim and predictable payments. However, it still carries default risk. Private equity can deliver higher returns but with much greater risk.
