Types of Private Credit
Last updated
Last updated
Here’s a detailed look at each of these types of private debt, along with real-world examples for clarity:
Senior Debt: Senior debt is a loan that has the first claim on a company’s assets if it defaults. Because it’s backed by collateral (like machinery, real estate, or inventory), senior debt tends to be safer for lenders and offers a lower interest rate to borrowers.
Example: A manufacturing company takes out a senior loan to purchase new equipment. If the company defaults, the lender can seize the equipment to recover the loan amount. Private equity firms often use senior debt to leverage their acquisitions, such as when a firm acquires a company and funds part of the purchase through a senior loan.
Mezzanine Debt: Mezzanine debt sits between senior debt and equity in terms of repayment priority. It is often unsecured and comes with higher interest rates, plus it may include warrants or equity options, giving lenders a share in the company’s upside.
Example: A technology company that needs additional capital to expand might take on mezzanine debt. The lender may receive a higher interest rate, along with the option to convert some of the debt into equity, which allows them to benefit if the company succeeds in its expansion.
Unitranche Debt: This combines senior and subordinated debt into a single loan with a blended interest rate. It simplifies the capital structure and can be more efficient for borrowers.
Example: When a private equity firm purchases a portfolio company, it might finance part of the acquisition with a unitranche loan. This single, streamlined loan structure provides more flexibility than having separate senior and mezzanine loans, often making it attractive in complex transactions.
In distressed debt investing, investors buy debt from companies in financial trouble, often at a discount. The investor’s goal may be to profit from a company’s recovery or to gain control through restructuring.
Example: During the 2008 financial crisis, hedge funds and private equity firms bought distressed debt from companies like General Motors and Lehman Brothers at a fraction of its value. When these companies either recovered or their assets were liquidated, investors received returns, often benefiting from asset sales or restructured terms.
Special situations debt targets companies in unique circumstances that don’t qualify for standard loans. These situations might include financing needs for growth, acquisitions, turnarounds, or restructuring.
Example: A company seeking capital to acquire a competitor might not meet the standard lending criteria because of high risk. A special situations lender might step in to provide financing in exchange for a higher interest rate and additional conditions, such as rights to future cash flows from the acquisition.
Venture debt is tailored for high-growth startups that need funding beyond their equity financing. It is typically offered alongside venture capital and does not require the startup to give up additional equity.
Example: A software startup that has just raised $10 million in venture capital funding may take on $2 million in venture debt to extend its cash runway until the next funding round. This allows the company to reach important milestones (like product launches or revenue targets) without diluting existing investors’ ownership stakes.
ABL involves loans that are secured by a company’s assets, such as accounts receivable, inventory, or equipment. ABL is particularly useful for asset-heavy companies that might have cash flow constraints.
Example: A retailer with significant inventory and accounts receivable might use asset-backed lending to improve cash flow for seasonal demand. The retailer pledges its inventory and accounts receivable as collateral, allowing it to borrow money to cover operational expenses or growth initiatives.
Invoice financing allows companies to borrow against unpaid invoices, offering immediate access to funds tied up in receivables. It’s an effective way for businesses with slow-paying clients to improve cash flow.
Example: A small business that provides consulting services to large clients might experience a cash flow gap due to extended payment terms. By using invoice financing, the business can receive an advance on its outstanding invoices and continue operations without waiting 60–90 days for clients to pay.
Each of these types of private debt/credit serves specific business needs, offering different risk-return profiles and structuring to meet both borrower and lender requirements.
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