A relatively new class of asset that is proving popular as another avenue for private equity investment is ‘private debt’. Private debt is, at its core, debt which is not held by banks.
Your Guide To Private Debt
A relatively new class of asset that is proving popular as another avenue for private equity investment is ‘private debt’. Private debt is, at its core, debt which is not held by banks. For example, a private company may hold a loan or extend a loan to another company. There are many different ways in which this can manifest. A company can directly extend a loan to another, or they can lend and borrow on private secondary markets. These come in a variety of flavours, through vehicles such as funds and real estate.
A New Revenue Stream
Private debt is a relatively new concept in the private equity market, and it represents a new source of funding and revenue for companies and private investors. Investment comes in various forms, from companies who specialise in acquiring distressed debt to others who invest in real estate development projects. It is an option for companies who, for one reason or another, would prefer to seek funding outside of the traditional banking sector.
Popular alternative to banks
As a percentage of the private market, it’s fairly significant – it makes up 10-15% of total assets under management by private middle market companies. There is also more flexibility in the terms of the debt, as they are typically more negotiable and flexible than with traditional banking institutions. Thanks to that flexibility, in some cases, debt held in private markets can be considered less risky than equity in other areas, due to the larger variance in variables such as interest rates and the general wider business cycle.
Types of debt
As mentioned above, there are many different types of debt that can be held or extended privately. This has resulted in several terms to describe the different possibilities. Check out the terms below for an example of the vocabulary used.
This is largely what it sounds like. One company make extend or take a loan from another company, the debt remaining privately held on both ends. This can be in a variety of forms from individual projects to ongoing credit lines. There are even unitranche funds forming, which combine different lines of debt into a single fund.
Companies can seek or extend financing for companies that are on the verge of bankruptcy or otherwise in financial distress. There can be many reasons for acquiring distressed debt, from rescuing companies to taking ownership of them.
This is debt extended to companies with funding from venture capital firms. It is a popular avenue for start ups and entrepreneurs to extend the round of fund raising after gaining backing.
Real estate debt
This represents a popular avenue for real estate acquisition. They can take the form of direct investment into projects or the trading of securitized real estate loans. Real estate represents a varied risk profile to most debt, as it is determined by the value of the underlying assets.
This is debt used for the purpose of investing in infrastructure assets and other existing assets. This can often take the form of very long term loans (extending past three decades or more) as those infrastructure assets are likely to have a longer profitable lifespan.
Debt can also be used as a vehicle to gain ownership of a company. This is most commonly done with the acquisition of distressed debt.
Debt which represents a claim on a company’s assets that is subordinate to equity but above secured senior debt and common shares. This type of debt is usually not backed by any asset and rather relies on a company’s ability to repay from general cash flow.
Invest outside traditional financing
There are many varied types of debt under the umbrella private term. It is a hugely diverse debt market and represents great opportunities for companies to both raise funds and diversify investments. Each type of debt represents a different risk profile, and resources can vary from being directly invested into projects to being pooled into funds which amalgamate debts and average out risk.
As an equity investor, it can particularly appeal to those who are familiar with the assets involved. Projects including direct investment make for especially good investment opportunities for those with advanced knowledge of the underlying assets and an increased understanding of risk profiles. For the companies raising funds, it can represent a lifeline when traditional funding institutions, such as banks, are either unwilling or unable to lend the funds required. Alternatively, it can be seen as another way of acquiring leverage in the underlying represented assets through the means of ownership or making claims of ownership above those of other debt holders.