Private credit (a.k.a. private lending or direct lending) is the business of financing companies and assets outside of public bond and syndicated loan markets. Since banks tightened post-crisis and rates jumped, private credit has become a core sleeve for institutions and family offices seeking floating-rate income, downside protection, and diversification. Here’s a plain-English tour of the major private credit strategies, how they make money, and what to watch before you allocate.

Why borrowers choose private credit

Speed, certainty, and customization. Sponsors and founders turn to private lenders for:

• Faster execution than syndicated markets.
• Flexible structures (bespoke covenants, delayed-draw tranches, PIK toggles).
• Confidentiality and reduced market risk versus broadly marketed deals.
  Investors get negotiated terms, security, and often floating-rate coupons (SOFR + spread) that reset with interest rates.

Core private credit strategies (from senior to spicy)

1. Senior Secured / Direct Lending
• First-lien loans to middle-market companies, typically sponsor-backed.
• Collateralized by substantially all assets; covenants range from maintenance to “cov-lite.”
• Return drivers: base rate + spread, OID (original issue discount), fees, call protection.
• Risk: borrower cyclicality, add-backs inflating EBITDA, documentation erosion.
2. Unitranche
• Blends senior and junior risk into one facility with a single blended rate; common in PE buyouts.
• Simplifies capital structure; intercreditor frictions move inside the “agreement among lenders.”
• Slightly higher yield than pure first lien; similar underwriting focus.
3. Second Lien & Mezzanine
• Subordinated to first-lien lenders; sometimes unsecured.
• Higher coupons, frequent PIK features, equity kickers (warrants).
• Used to reduce equity checks in acquisitions or fund expansions.
• Watch intercreditor rights, baskets, and leakage (restricted payments).
4. Opportunistic / Special Situations
• Rescue financing, bridge loans, covenant resets, non-sponsor borrowers.
• Creative structures: priming liens, super-priority DIPs, structured preferred.
• Event-driven returns; higher complexity and legal intensity.
5. Distressed Credit
• Buying discounted loans/bonds or providing debtor-in-possession (DIP) financing to influence restructurings.
• Outcomes include loan-to-own or post-reorg equity.
• Requires legal expertise and patience; vintage matters.
6. Asset-Based Lending (ABL) & Receivables Finance
• Loans secured by working capital (A/R, inventory) with borrowing bases and frequent field exams.
• Lower loss-given-default if controls are strong; returns enhanced by fees and revolver dynamics.
7. NAV Lending & GP/Management Lines
• Loans at the fund or GP level secured by diversified portfolios (private equity, secondaries) or management fee streams.
• Used for liquidity, continuation vehicles, or pacing distributions.
• Key is collateral quality, overcollateralization, covenants, and LTV triggers.
8. Real Estate Debt
• Senior mortgages, mezz loans, construction and bridge financing, preferred equity.
• Focus on LTV, DSCR, sponsorship, take-out risk, and market supply pipelines.
9. Venture Debt
• Loans to VC-backed companies with limited EBITDA but strong growth and equity backing.
• Priced with warrants and covenants tied to liquidity/runway and milestone tests.
• Higher dispersion; underwrite cash burn, unit economics, and syndicate support.
10. Trade Finance / Equipment Leasing / Specialty Finance

• Short-duration, self-liquidating exposures; secured by specific collateral (inventory, invoices, equipment).
• Attractive carry with tight servicing; operational risk is the swing factor.

How lenders create (and protect) returns

• Underwriting: Normalize EBITDA (strip add-backs), test cash conversion, model downside cases.
• Security package: First-priority liens, guarantees, blocked accounts, springing cash dominion.
• Covenants: Leverage and interest-coverage tests, capex and acquisition baskets, MFN for add-ons.
• Economics: Spread, OID, upfront/unused fees, prepayment penalties, amendment fees.
• Monitoring: Monthly reporting, field exams, auditor comfort letters, board observer rights.
• Remedies: Step-in rights, collateral control, forbearance with fees, or priming in restructurings.

The risk checklist (read this twice)

• Refinancing risk: Maturities bunching into tight markets. Stagger and require minimum liquidity.
• Documentation creep: “Cov-lite” and generous baskets can hollow protections—negotiate leakage limits.
• Add-backs & pro formas: Overly rosy synergies distort leverage; use hard caps and sunset provisions.
• Sector concentration: Healthcare reimbursement, cyclical industrials, ad-tech—know the macro sensitivity.
• Sponsor behavior: Track record on support, rescue capital, and governance matters in downturns.
• Jurisdiction & liens: Foreign subs, IP perfection, UCC filings—details decide recoveries.
• Vintage risk: Late-cycle loans at peak leverage/valuations carry more downside.

Portfolio construction for allocators

• Blend core direct lending with smaller sleeves in opportunistic, ABL, and real estate debt for balance.
• Favor managers with origination depth (proprietary deal flow), workout experience, and tight servicing.
• Size the allocation to your liquidity: closed-end funds lock capital 5–7+ years; BDCs offer listed access but add market beta.
• Expect fees around 1–1.5% base + 10–15% incentive over a hurdle with a catch-up; focus on net returns and loss history.

Key metrics that matter

• Leverage: Net Debt / EBITDA; set guardrails by sector.
• Coverage: EBITDA / Cash Interest; test rising-rate sensitivity.
• Loan-to-Value (LTV) and DSCR for asset-backed and real estate loans.
• Attachment/Detachment points: Where you sit in the stack and expected loss-given-default.
• Covenant tightness: Definitions, cushions, cure rights.
• Recovery history: Realized loss rate, time-to-workout, variance by strategy.

Where private credit fits in a portfolio

• Income engine with lower correlation to public equities than high yield.
• Inflation defense via floating-rate coupons.
• Downside control through collateral and covenants (when negotiated well).
  Size prudently; this is illiquid credit—not cash. Match commitments to long-term capital.

Practical diligence questions for managers

• What % of deals are sponsor-backed vs. non-sponsor?
• Average LTV/leverage, covenant packages, and documentation philosophy?
• Sourcing edge—bank carve-outs, sponsor relationships, specialty channels?
• Workout team credentials and realized loss history through stress periods?
• Pipeline, dry powder, and pacing discipline in hot markets?

Bottom line

Private credit strategies span a spectrum—from conservative first-lien loans to event-driven and distressed special sits. The edge comes from disciplined underwriting, durable documentation, and gritty servicing when things go sideways. Blend strategies thoughtfully, pick managers with real origination and workout muscles, and size the allocation to your liquidity. Get those pieces right, and private credit can deliver resilient income with genuine downside protection.

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