What is private debt?

Sep 22, 2022

Private debt includes any debt held by or extended to privately held companies. It comes in many forms, but most commonly involves non-bank institutions making loans to private companies or buying those loans on the secondary market.

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 funds provide capital to sponsor-backed borrowers, others fund real estate development projects, and some invest entirely in the debt of distressed companies.

Most private middle market companies have at least some debt. Investor demand for debt funds is on the rise. Depending on interest rates, regulations, business cycles and other factors, investors may view private debt as a lower-risk approach to private equity or the diversification of their assets.

Growth of private debt in recent years

Industry titans like Apollo and Oaktree have been raising private debt vehicles since the 1990s. However, the industry was less developed and more concentrated in the years leading up to the Global Financial Crisis (GFC), only gaining widespread recognition in the last decade.

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

The number of new private debt funds plummeted to a 9-year low in 2020, while the amount of new capital raised dropped to its lowest point in five years. The pandemic inspired a wave of distressed debt and special situations funds from investors eager to capitalize on new opportunities, and private debt was primed to bounce back in 2021.

So although private debt fundraising declined worldwide during the height of the pandemic, the rebound in 2021 has been swift thanks to:

  • A surging economy
  • Liquidity in the credit markets
  • Businesses avoiding default

Types of private debt

PitchBook takes a hybrid approach considering seniority in the capital structure, risk/return profile and industry exposure.

  • Direct lending

Senior loans made to mid-market companies without an intermediary. May include revolving credit lines and second lien loans. Unitranche facilities, which combine different debt instruments under a single umbrella, are also becoming more common.

  • Special situations

Debt or structured equity investments 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

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.

  • 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

Mezzanine debt is a type of subordinated debt with embedded equity instruments attached. Those instruments are called warrants, which are equity participation rights. Embedded equity with the debt can also include call options and rights. Mezzanine debt is often used in the context of leveraged buyouts (LBOs).

Subordinated debt refers to loans with a lower priority than senior (or secured) debt in the event of bankruptcy or liquidation. Also called junior debt, subordinated debt is a lesser priority when it comes to repayments, too.

A leveraged buyout, or LBO, is when an investor purchases a controlling stake in a company using a combination of equity and a significant amount of debt, which must eventually be repaid by the company. The investor works to improve the company’s profitability so that the repayment of the debt is less of a financial burden for them.

  • Real estate debt

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

  • 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.

The above information has been sourced from What is private debt and What is mezzanine debt. Access the Global Private Debt report. 

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