Private credit and private equity investments offer investors opportunities to build their portfolios in substantially different ways. With private credit, investors make loans to businesses and earn returns through interest. Private equity represents an ownership stake in a private company or a public company that is not traded on a stock exchange.
Each one serves a different purpose, which can be important for investors to understand.
Key Points
• Private credit and private equity are alternative investments that offer different ways to build portfolios.
• Private credit involves making loans to businesses and earning returns through interest, while private equity represents ownership stakes in private or delisted public companies.
• Private credit investors include institutional investors, high-net-worth individuals, and family offices, while private equity investments are often made by private banks or high-net-worth individuals.
• Private credit generates returns through interest, while private equity aims to generate returns through the sale of a company or going public.
• Private credit carries liquidity risk, while private equity investments can be affected by the company’s performance and potential bankruptcy.
What Does Private Credit and Private Equity Mean?
Private equity and private credit are two types of alternative investments to the stocks, bonds, and mutual funds that often make up investor portfolios. Alternative investments in general, and private equity or credit in particular, can be attractive to investors because they can offer higher return potential.
However, investors may also face more risk.
💡 Quick Tip: While investing directly in alternative assets often requires high minimum amounts, investing in alts through a mutual fund or ETF generally involves a low minimum requirement, making them accessible to retail investors.
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Private Credit Definition
Private credit is an investment in businesses. Specifically, an investor or group of investors extends loans to private companies and delisted public companies that need capital. Investors collect interest on the loan as it’s repaid. Other terms used to describe private credit include direct lending, alternative lending, private debt, or non-bank lending.
Who invests in private credit? The list can include:
• Institutional investors
• High-net-worth individuals
• Family offices or private banks
Retail investors may pursue private credit opportunities but they tend to represent a fairly small segment of the market overall. Private credit investment is expected to exceed $3.5 trillion globally by 2028.
Private Equity Definition
Private equity is an investment in a private or delisted public company in exchange for an ownership share. This type of investment generates returns when the company is sold, or in the case of a private company, goes public.
Similar to private credit, private equity investments are often the domain of private banks, or high-net-worth individuals. Private equity firms can act as a bridge between investors and companies that are seeking capital. Minimum investments may be much higher than the typical mutual fund buy-in, with investors required to bring $1 million or more to the table.
Private equity is often a long-term investment as you wait for the company to reach a point where it makes sense financially to sell or go public. One difference to note between private equity and venture capital lies in the types of companies investors target. Private equity is usually focused on established businesses while venture capital more often funds startups.
What Are the Differences Between Private Credit and Private Equity?
Private credit and private equity both allow for investment in businesses, but they don’t work the same way. Here’s a closer look at how they compare.
Investment Returns
Private credit generates returns for investors via interest, whereas private equity’s goal is to generate returns for investors after selling a company (or stake in a company) after the company has grown and appreciated, though that’s not always the case.
With private credit, returns may be more predictable as investors may be able to make a rough calculation of their potential returns. Private equity returns are less predictable, as it may be difficult to gauge how much the company will eventually sell for. But there’s always room for private equity returns to outstrip private credit if the company’s performance exceeds expectations. However, it’s important to remember that higher returns are not guaranteed.
Risk
Investing in private credit carries liquidity risk, in that investors may be waiting several years to recover their original principal. That risk can compound for investors who tie up large amounts of capital in one or two sectors of the market. Likewise, changing economic conditions could diminish returns.
If the economy slows and a company isn’t able to maintain the same level of revenue, that could make it difficult for it to meet its financial obligations. In a worst-case scenario, the company could go bankrupt. Private credit investors would then have to wait for the bankruptcy proceedings to be completed to find out how much of their original investment they’ll recover. And of course, any future interest they were expecting would be out the window.
With private equity investments, perhaps the biggest risk to investors is also that the company closes shop or goes bankrupt before it can be sold but for a different reason. In a bankruptcy filing, the company’s creditors (including private credit investors) would have the first claim on assets. If nothing remains after creditors have been repaid, private equity investors may walk away with nothing.
The nature of the company itself can add to your risk if there’s a lack of transparency around operations or financials. Privately-owned companies aren’t subject to the same federal regulation or scrutiny as publicly-traded ones so it’s important to do thorough research on any business you’re thinking of backing.
Ownership
A private credit investment doesn’t offer any kind of ownership to investors. You’re not buying part of the company; you’re simply funding it with your own money.
Private equity, on the other hand, does extend ownership to investors. The size of your ownership stake can depend on the size of your investment.
Investor Considerations When Choosing Between Private Credit and Private Equity
If you’re interested in private equity or private credit, there are some things you may want to weigh before dividing in. Here are some of the most important considerations for adding either of these investments to your portfolio.
• Can you invest? As mentioned, private credit and equity are often limited to accredited investors. If you don’t meet the accredited investor standard, which is defined by income and net worth, these investments may not be open to you.
• How much can you invest? If you are an accredited investor, the next thing to consider is how much of your portfolio you’re comfortable allocating to private credit or equity.
• What’s your preferred holding period? When evaluating private credit and private equity, think about how long it will take you to realize returns and recover your initial investment.
• Is predictability or the potential for higher returns more important? As mentioned, private credit returns are typically easy to estimate if you know the interest rate you’re earning. However, returns may be lower than what you could get with private equity, assuming the company performs well.
Here’s one more question to ask: how can I invest in private equity?
These investments may not be available in a standard brokerage account. If you’re looking for private credit opportunities you may need to go to a private bank that offers them. When private equity is the preferred option, a private equity firm is usually the connecting piece for those investments.
When comparing either one, remember to consider the minimum initial investment required as well as any fees you might pay.
💡 Quick Tip: Did you know that opening a brokerage account typically doesn’t come with any setup costs? Often, the only requirement to open a brokerage account — aside from providing personal details — is making an initial deposit.
The Takeaway
Private credit and private equity can diversify a portfolio and help you build wealth, though not in the same way. Comparing the pros and cons, assessing your personal tolerance for risk and ability to invest in either can help you decide if alternative investments might be right for you.
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FAQ
Why do investors like private credit?
Private credit can offer some unique advantages to investors, starting with predictable returns and steady income. The market for private credit continues to grow, meaning there are more opportunities for investors to add these types of investments to their portfolios. Compared to private equity, private credit carries a lower degree of risk.
How much money do you need for private equity?
The minimum investment required for private equity can vary, but it’s not uncommon for investors to need $100,000 or more to get started. In some instances, private equity investment minimums may surpass $1 million, $5 million, or even $10 million.
Can anyone invest in private credit or private equity?
Typically, no. Private credit and private equity investments most often involve accredited investors or legal entities, such as a family office. It’s possible to find private credit and private equity investments for retail investors, however, you may need to meet the SEC’s definition of accredited to be eligible.
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