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Definition and origin

Private debt—also referred to as private lending or private financing—is a form of financing that is not provided by traditional financial institutions such as banks. Instead, capital is sourced from private investors or specialised investment funds. The risk/return profile of this financing sits between equity and conventional bank debt. It emerged in the aftermath of the 2008 financial crisis as an attractive alternative for companies that cannot—or prefer not to—access traditional bank credit or public capital markets.

Types of debt instruments

As with private equity investing, private debt encompasses a wide range of instruments—from senior loans to mezzanine loans, distressed claims and hybrid securities. Below are a few of the most common forms.

Senior private debt

Senior debt is a widely used financing instrument in corporate transactions. It is regarded as the safest form of debt for investors because it benefits from repayment priority over other liabilities in the event of borrower insolvency.

Definition of senior private debt

Senior debt ranks ahead of other forms of debt in a bankruptcy waterfall. It is typically secured by company assets or a personal guarantee from the borrower, and in a liquidation it is repaid before other creditors and shareholders.

Key advantages for borrowers include:

• Lower interest rates: senior debt generally carries a lower coupon than other forms of debt, reflecting its lower risk profile for investors.
• Flexibility: structures can be tailored to specific needs, including deferred amortisation or interest-only periods.
• No dilution: unlike issuing equity, senior debt does not dilute existing shareholders.

Benefits for investors include:

• Priority of repayment: in a default, senior creditors are paid first, before other creditors and shareholders.
• Higher yields than government bonds: senior loans often offer a premium over sovereign debt, appealing to investors seeking enhanced returns.
• Lower risk: seniority in the capital structure reduces loss severity relative to subordinated instruments.
• Collateral requirements: security interests can constrain a borrower’s capacity to raise additional debt in future.
• Financial covenants: leverage or coverage tests can limit borrower flexibility.
• Mandatory repayment: unlike some subordinated instruments, principal must be repaid at maturity, which may create cash-flow pressure.

In sum, senior debt is a mainstream private debt strategy in corporate finance: borrowers benefit from lower cost and structural flexibility, while investors gain priority protection in a downside scenario.

Junior or mezzanine loans

Mezzanine debt is hybrid financing that blends features of debt and equity. It is often used in leveraged buyouts (LBOs) and real-estate projects.

Definition of mezzanine debt

Mezzanine debt is subordinated: it sits below senior debt but above equity in the capital structure. It is typically unsecured and cannot be repaid ahead of senior facilities in insolvency. Given its higher risk, it commands a higher yield. Instruments may include warrants or options, giving investors potential participation in equity upside.

Key points for the borrower

• Flexible financing: can support acquisitions, buyouts, capex and real-estate developments.
• Long-term capital: typically amortised over a longer horizon than senior debt.
• Cash-flow relief: interest may be deferred or PIK-capitalised, easing near-term outflows.

For the investor

Investor benefits include:

• Higher returns: compensation for subordinated risk.
• Profit participation: warrants/options can add equity-linked upside.
• Diversification into private assets: exposure to unlisted mid-market companies.

Keep in mind

Considerations include:

• Higher risk: subordinated position increases loss severity.
• Higher cost: coupons and fees exceed senior facilities.
• Potential dilution: equity-linked features may dilute existing owners.
• Financial restrictions: covenant packages may still constrain flexibility.

In short, mezzanine combines long-term, flexible capital for borrowers with enhanced yield and optionality for investors—balanced by higher risk and cost.

Unitranche debt

Unitranche debt combines senior and subordinated risk into a single tranche, commonly used in LBOs and acquisition financings. Its appeal lies in structural simplicity and execution speed.

Definition of unitranche debt

A single loan with one interest rate and maturity, typically provided by a single lender or a club. It blends first-lien economics with a portion of subordinated risk, reflected in pricing.

Unitranche for the borrower

• Simplified structure: one facility replaces multiple tranches, reducing complexity and transaction costs.
• Flexibility: more adaptable repayment profiles and covenant frameworks.
• Faster execution: fewer parties and documents accelerate timelines.

For investors

• Higher returns: premium over pure senior risk.
• Private-markets diversification: access to mid-market, non-listed borrowers.
• Negotiating leverage: concentrated lender group can secure stronger terms.

Keep in mind

• Higher cost: priced above senior debt to reflect blended risk.
• Higher credit risk: incorporates subordinated exposure within one instrument.
• Lower liquidity: typically less tradable than public corporate bonds.

Overall, unitranche is a flexible, increasingly prevalent solution—offering borrowers streamlined execution and investors enhanced yield.

Bridge loans

In private equity transactions, a bridge loan provides temporary financing between signing/closing and the implementation of permanent funding. Common in LBOs and MBOs, bridges typically span a few months up to one year, enabling timely completion while permanent facilities are finalised.

Bridge loans carry higher interest than long-term debt to compensate for elevated short-term risk and can be repaid early once permanent financing is in place. Providers include private debt funds, banks and private equity firms (using their own capital pending refinancing).

In essence, bridge loans ensure transaction certainty and speed, while investors and lenders complete documentation for the long-term capital structure.

Summary by risk level

1. Senior debt: safest for creditors due to priority repayment; often secured by company assets.
2. Mezzanine debt: hybrid risk between debt and equity; used for specific projects or acquisitions; typically higher coupons than senior/junior bank debt.
3. Unitranche debt: combines senior and mezzanine characteristics; common in LBOs; risk above senior but below pure mezzanine.
4. Equity: highest risk—last in priority—but offers the greatest potential upside through ownership.

History of private debt funds: emergence and current appeal

Private debt funds focus on financing corporate liabilities and have evolved alongside economic and regulatory shifts.

Emergence of debt funds

Private debt funds emerged in the United States in the 1980s amid banking-market deregulation. Banks syndicated and sold leveraged loans to institutional investors (pension funds, insurers), creating a secondary market. Dedicated funds arose to purchase these loans and deliver attractive returns.

Rise during the financial crisis

The 2008 crisis curtailed traditional bank lending, leaving a financing gap that private debt funds helped to fill. Institutions, seeking diversification into private assets, increased allocations to private credit.

Post-crisis regulation—most notably Basel III—raised capital requirements on banks, constraining their lending capacity and further supporting the growth of alternative lenders.

Appeal in the current environment

Private debt’s popularity has continued, supported by several factors. Years of historically low rates reduced the appeal of public bond yields, steering investors toward higher-yielding private credit. The COVID-19 period created incremental financing needs that private lenders addressed with tailored, time-sensitive facilities.

Today, the reverberations of the fastest rate-hiking cycle in four decades, together with regulatory tightening and disciplined bank capital deployment, continue to limit traditional lending. Companies therefore turn to bespoke private solutions—while investors benefit from attractive return profiles.

In short, private debt funds have grown from their 1980s origins, expanded through the 2008 cycle, and remain a core private-markets allocation for institutions and sophisticated investors.

Percentage of deals financed by credit funds vs. European banks (1)
(1) European Banking Federation

Focus on the Capital Solutions strategy

Capital Solutions is a private debt approach used by leading international managers (e.g., CVC Capital Partners, Arcmont Asset Management) to deliver tailor-made financing for companies whose needs are not met by traditional bank or bond channels—often in cyclical slowdowns or sector-specific dislocations.

Managers build highly diversified portfolios, typically alongside sponsor-backed deals. Portfolios blend hybrid financings across instruments, with a majority of primary transactions and selective equity positions, as well as secondary or complex situations.

Benefits of the strategy

For companies

• Flexibility and customisation: financing tailored to specific needs, often on terms more suitable than standard bank offerings.
• Speed of execution: private lenders can commit and close rapidly.
• Expertise and support: managers bring deep structuring experience and operational guidance.

For investors

• Short investment duration
• Diversification on three levels: company exposure, global geography, multi-sector allocation
• Sponsor-backed transactions alongside top-tier global managers
• Rapid income distribution
• Attractive return targets with a high IRR objective

As with any private-assets strategy, risks include credit, liquidity and interest-rate risks.

Illustrative LBO transaction with a private debt fund

In an LBO, a private equity sponsor acquires a company using leverage—i.e., financing a portion of the purchase with debt. A holding company (HoldCo) is formed to acquire the target’s shares, and a private debt fund provides part of the financing. Key steps include:

Step 1: Target identification and price negotiation
The sponsor selects a target and agrees a purchase price with existing shareholders, then sets up a dedicated HoldCo.

Step 2: Debt structuring
A private debt fund structures facilities aligned to the target’s risk profile and repayment capacity—typically a senior tranche (lower risk, lower yield) and a junior tranche (higher risk, higher yield).

Step 3: Equity contribution
The sponsor contributes equity capital, sourced from the PE fund’s LPs and/or co-investors.

Step 4: HoldCo creation
The sponsor finalises the acquisition vehicle structure with relevant co-investors.

Step 5: Acquisition of the target
HoldCo purchases the target’s shares. Consideration is funded through private debt facilities and sponsor equity.

Step 6: Post-acquisition value creation
The sponsor implements new governance and a value-creation plan to grow enterprise value.

Step 7: Debt service
Operating cash flows service the private debt. Lenders receive interest and enjoy repayment priority over HoldCo shareholders.

Step 8: Exit
Once value objectives are met, the sponsor exits via a secondary sale to another PE fund, an IPO, or a strategic buyer—crystallising gains for shareholders.

Investor implications

PE fund investors gain the benefit of leverage-enhanced equity returns but bear higher risk than private debt investors, who are repaid first in a default scenario.

Private debt investors receive contractual interest and priority in a downside, but upside is capped versus equity in a successful outcome.

How a private debt fund operates

Operations can be viewed from the lens of both the fund and the end investor.

From the private debt fund’s perspective

1. Fundraising: capital is raised from institutional and private investors (insurers, pensions, family offices, HNWIs, etc.).
2. Investment: capital is deployed into debt instruments issued by companies, projects or assets, in line with mandate (senior, mezzanine, subordinated loans, bonds, structured notes, etc.).
3. Active management: credit monitoring, covenant negotiations, financial analysis and portfolio steering.
4. Repayment and distribution: as loans mature or prepay, proceeds are returned pro-rata; profits are distributed via dividends or redemptions.

From the investor’s perspective

1. Subscription: investors commit based on capacity and risk appetite, subject to eligibility criteria (minimums, lock-ups, etc.).
2. Remuneration: returns are primarily interest income plus portfolio performance.
3. Risks: credit, interest-rate, liquidity and market risks per strategy and asset quality.
4. Exit: secondary transfers may be possible, subject to notice, lock-ups and fees.

In essence, private debt funds channel capital into corporate liabilities in exchange for contractual income. Managers seek to optimise risk-adjusted returns through selection, structuring and active oversight.

FAQs

How do private debt funds generate returns for investors?

Primarily through interest payments made by borrowers on loans provided by the fund.

What types of companies do private debt funds lend to?

Typically mid-market companies across diverse industries, often financing growth, acquisitions or refinancing.

How does private debt compare to public debt?

Private debt offers higher potential returns and bespoke terms but entails higher risk and lower liquidity. Public debt (government or corporate bonds) is generally more liquid with lower risk—and lower returns.

Can individual investors access private debt funds?

Yes—though access is often limited to sophisticated or professional investors given the risk profile and longer horizons.

Is private debt affected by stock-market volatility?

It is typically less correlated with equities, supporting portfolio diversification and volatility management.

To explore our full offering across private assets—including private debt, private equity and infrastructure—please contact us.