Private credit vs private equity
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Updated: May 24, 2024
Private credit and private equity can be essential tools for investors looking to raise funds outside banking or traditional financial markets. Private credit represents direct lending, typically a loan to a small to mid-sized business from a wealthy individual or another company. Private equity is a term for directly investing in a company, where the investor takes ownership of a portion of the company.
Here’s a closer look at private credit vs. private equity to help you understand the differences and how they may fit into your investment strategy.
Private credit investing explained
Private credit is a term for loans made to a business outside bank loans and traditional debt financing, such as corporate bonds. Private credit investors are sometimes willing to make riskier loans to startups and struggling businesses for a higher interest rate. In comparison, banks and traditional business financing vehicles may not be open to these riskier loans.
The lender and the borrower can negotiate unique terms that suit their needs and goals. That can include long payoff periods, a delay before the first payment is due, an option to convert debt to equity, or anything else they find to be a win-win scenario.
Private credit investing pros and cons
Here’s a look at several of the most important pros and cons of private credit for investors:
Pros
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High yield for investors
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Enables businesses to access non-traditional lending sources
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Flexible lending terms
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Predictable cash flow
Cons
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Higher risk of losses
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Low liquidity
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More challenging due diligence
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Potential complexity
Private equity explained
Private equity is a term for private investments in a business in exchange for partial ownership. Examples include angel investing by wealthy individuals, venture capital funding for startups, and more significant deals from specialized private equity firms and large investment companies.
Instead of raising capital by issuing shares of stock in the public stock markets, private equity enables companies and investors to reach mutually agreed-upon terms, including negotiating an off-market valuation of the business. For companies receiving private equity investments, managers can access additional funds without the scrutiny of the Securities and Exchange Commission (SEC) and Federal Trade Commission (FTC) requirements for public companies. For investors, it’s a chance to get in early and own stock in a growing business before the general public.
Private equity investing pros and cons
For investors, these are several of the most important pros and cons of private equity:
Pros
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High potential returns
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More influence over the business
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Access to unique investment opportunities
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Diversification into less traditional investments
Cons
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Higher risk of losses
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Low liquidity
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May have to wait many years for a payoff
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Large minimum investment
Private credit vs private equity: How they’re different
- Type of investment: Private credit involves lending money to private companies and earning returns through interest payments. Private equity involves purchasing equity stakes in private companies, aiming to profit from their growth and eventual sale.
- Risk and return profile: Private credit typically offers more stable and predictable returns through interest payments but with lower upside potential. Private equity carries higher risk due to its reliance on company performance but offers potentially higher returns from equity appreciation.
- Active vs. passive management: Private credit investors usually play a more passive role, primarily focusing on borrowers' creditworthiness and loan terms. However, private equity investors often take an active role in managing and improving the operations of portfolio companies.
- Income generation vs. capital appreciation: Private credit focuses on generating regular income through interest payments, making it attractive for income-seeking investors. Private equity focuses on capital appreciation through the growth and eventual sale of the company, making it suitable for investors seeking long-term capital gains.
Private credit vs private equity: How they’re the same
- High potential returns: Both types of investments aim to deliver higher returns than traditional fixed-income or equity investments, compensating for their higher risk and lower liquidity.
- Access to private markets: Investors in private credit and private equity gain exposure to private companies, which are not available through public markets.
- Liquidity: Private credit investments are generally more liquid than private equity investments, although both are less liquid than public market investments. Private equity investments often have long lock-up periods before investors can realize returns.
- Exclusive access: It's worth noting that due to the high minimum investment requirements and the complexity of the investments, both private credit and private equity are typically accessible to a select group of investors, namely institutional investors and accredited individuals.
Is private credit investing right for me?
Private credit suits investors willing to take on higher risk for potentially higher returns. Private credit investments are typically less scrutinized than public bond market investments, so investors should be prepared for a more significant effort to analyze and select private credit investments.
Due to the higher risk involved, private credit is best for investors with stable finances who can afford to lose their investment if it doesn’t work out as expected. If you’re an experienced investor with extensive knowledge of risk and return assessment, you may find success in private credit investing.
How to begin investing in private credit
Unless you have relationships allowing you to make direct private credit investments, you should consider investing in private credit through platforms created to allow the average investor better access to private credit markets.
An example is the Arrived Private Credit Fund, giving investors access to private credit real estate investments. Clients of Arrived and similar platforms pool their money to unique investment opportunities.
Is private equity investing right for me?
Private equity is often reserved for high-net-worth individuals and highly focused private equity investment firms. However, like private credit, other educated and experienced investors may be able to gain access to private equity deals. Like private credit, you should only proceed if you completely understand the risks and potential payoff of the company you’re considering for an investment.
Also, like private credit, investing only in what you can afford to lose is best. While you’ll hopefully earn 10x or more from private equity investments, there’s always a chance the company will go out of business, and you won’t see any return.
How to begin investing in private equity
Direct private equity deals are often only offered to investors with high net worths reaching the millions. However, if you have a six-figure net worth, you may still find platforms allowing you to pool your money with others in a private equity fund. You’ll generally need to meet the accredited investor criteria the SEC sets to participate.
If you’re an accredited investor, you can begin investing in private equity by searching for suitable funds and investment apps for your long-term financial goals.
Eric Rosenberg is a finance, travel and technology writer in Ventura, California. He is a former bank manager and corporate finance and accounting professional who left his day job in 2016 to take his online side hustle full time.
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