How to Invest in Private Credit: What You Need to Know

Private credit has emerged as an alternative asset class, a form of debt financing from non-bank lenders directly to companies. It has grown significantly, attracting investors seeking portfolio diversification and higher yields than traditional fixed income markets. Understanding this market is important for individuals considering its inclusion in their financial strategy. This article guides readers through private credit’s fundamental aspects and access methods.

Understanding Private Credit

Private credit involves direct lending relationships between investors and private companies, often mid-market companies. This financing operates outside conventional capital markets, unlike traditional bank loans and publicly traded bonds. Its fundamental characteristics include its illiquid nature, meaning investments are not easily bought or sold on public exchanges and often require holding until maturity due to their bespoke nature. Terms are directly negotiated. To compensate for this illiquidity, private credit generally offers higher yields than public debt instruments.

Many private credit arrangements feature floating-rate structures, with interest rates adjusting periodically based on a benchmark like the Secured Overnight Financing Rate (SOFR). This offers protection against rising interest rates, as the loan’s income stream increases with the benchmark rate. This contrasts with traditional fixed-rate bonds, whose market value typically declines when interest rates rise.

Private credit can manifest in various forms, each with distinct risk/return profiles. Direct lending involves senior secured debt, prioritized in repayment and secured by borrower assets if default occurs. Mezzanine debt represents a hybrid financing, ranking below senior debt but above equity, often including an equity component to enhance returns. Distressed debt strategies focus on purchasing the debt of financially troubled companies at a discount, aiming for recovery via restructuring or improved performance.

Accessing Private Credit Investments

Individuals can gain exposure to private credit through several avenues, each with distinct structures and accessibility. Private funds, often structured as limited partnerships, are the most common route for institutional and high-net-worth investors. Investors act as limited partners (LPs), committing capital to a fund managed by general partners (GPs) who identify and execute lending opportunities. This structure requires capital commitments drawn down over time as the fund identifies suitable investments.

These funds require substantial minimum investments, from $250,000 to millions of dollars, and involve long-term capital commitments spanning five to ten years or more. This extended lock-up reflects the illiquid nature of underlying private loans, allowing fund managers time to originate, manage, and exit investments. Investors access these funds through institutional placement agents, large wealth management firms, or direct relationships for ultra-high-net-worth individuals and family offices.

Business Development Companies (BDCs) offer a more accessible pathway for individual investors. BDCs are publicly traded entities that invest primarily in the debt and equity of private companies, especially small and middle-market firms. These entities are regulated under the Investment Company Act of 1940 and can be bought and sold on stock exchanges, similar to mutual funds or exchange-traded funds, providing daily liquidity.

Publicly traded BDCs have lower minimum investment requirements than private funds, as shares are purchased at market prices through a standard brokerage account. To maintain their status as Regulated Investment Companies (RICs) under the Internal Revenue Code, BDCs must distribute at least 90% of their taxable income to shareholders annually. This pass-through structure avoids corporate-level taxation on distributed income; shareholders pay taxes on dividends.

Beyond publicly traded BDCs, some BDCs are non-traded, their shares not listed on a national securities exchange. These non-traded BDCs offer less liquidity than their publicly traded counterparts, often providing only periodic redemption programs (e.g., quarterly). They provide private credit exposure to a broader investor base.

Online investment platforms pool capital from multiple investors to access private credit opportunities, sometimes allowing entry for accredited investors with $10,000 to $100,000. The process involves account creation, accredited investor verification, browsing offerings, and electronic fund commitment. Platforms may offer access to individual loans, diversified portfolios, or feeder funds.

While these methods offer various levels of accessibility, direct investment into private credit loans by individual investors is not practical. The capital scale, due diligence complexity, and specialized legal/financial expertise required make direct lending suitable primarily for very large institutional investors or sophisticated family offices with dedicated teams.

Important Investment Considerations

Before committing capital to private credit, investors must evaluate several factors. Many private credit opportunities, especially private funds and online platform offerings, require specific accreditation. Under the Securities and Exchange Commission’s Rule 501 of Regulation D, an individual is an “accredited investor” if they have a net worth exceeding $1 million (excluding primary residence) or an income exceeding $200,000 ($300,000 jointly) in each of the two most recent years. This status is mandated because these offerings are exempt from extensive public securities registration.

The liquidity profile of private credit investments is important. Most private credit investments are inherently illiquid, meaning capital is locked up for extended periods. For private funds, this lock-up can range from five to ten years, with some fund lifecycles extending to twelve to fifteen years or more, as capital is committed for the loan duration. This extended illiquidity means investors cannot readily access their capital and must ensure funds are not needed for short-to-medium term financial obligations.

Fees and expenses impact net returns. Private funds charge an annual management fee, often 1.5% to 2.0% of committed capital or net asset value, for operational costs. Fund managers also receive a performance fee, known as carried interest, 15% to 20% of profits generated above a hurdle rate. A hurdle rate is a minimum annual return (often 6% to 8%) limited partners must achieve before the general partner receives carried interest. Other fees (administrative, legal, audit) also reduce net returns, requiring review of comprehensive offering documents like the private placement memorandum or prospectus.

Thorough due diligence is important for any private credit investment. Investors should research the investment vehicle (fund, BDC, or online platform) and the underlying manager or company. Key areas include the manager’s private credit strategy, historical performance across economic cycles, the investment team’s experience and stability, and operational infrastructure. For BDCs, reviewing public filings (e.g., 10-K, 10-Q) provides insights into portfolio composition and financial health.

Private credit investments carry inherent risks. Credit risk is the primary concern, representing the possibility of borrower default on loan obligations, leading to loss of principal and interest. While many private credit loans feature floating interest rates, mitigating interest rate risk during rising rates, they remain sensitive to base rate changes. Economic downturns can severely impact borrowers’ ability to repay, increasing default rates and potentially leading to covenant breaches. Other risks include concentration risk (if the portfolio is not adequately diversified) and valuation risk, as illiquid assets are challenging to value accurately.

Investors should consider how private credit fits into their overall portfolio strategy. Its unique risk-return profile and illiquidity offer diversification benefits, as its performance may be less correlated with traditional public markets. Private credit also provides consistent income generation due to its contractual payments and floating-rate features. However, it should be viewed as one component within a broader, well-diversified investment strategy, aligning with an investor’s overall asset allocation, risk tolerance, and long-term financial goals.