Private debt refers to various forms of debt provided by investors to private entities. There are four categories.

Direct lending provides funds to borrowers that lack favorable alternatives to traditional bank lenders. The rates are normally higher, and the number of borrowers is usually very small. A leveraged loan is a type of loan that is extended to companies or individuals that already have considerable amounts of debt or poor credit history.

Mezzanine debt is the middle layer of capital that falls between secured senior debt and equity.

• junior ranking;
• unsecured;
• equity participation.

Mezzanine debt can be used as a financing source for corporate expansion projects, acquisitions, recapitalizations, management buy-outs (MBO) and leveraged buy-outs (LBO).

Venture debt is a type of loan designed specifically for early-stage, high-growth companies with venture capital backing. Instead of collateral, the lenders are compensated with the company's warrants on common equity for the high-risk nature of the debt instruments. The vast majority of venture-backed companies raise venture debt at some point in their lives from specialized banks such as Silicon Valley Bank.

Distressed debt refers to the securities of an issuer which has either defaulted, is under bankruptcy protection, or is in financial distress and moving toward the aforementioned situations in the near future. Why? The greater the level of risk you assume, the higher the potential return. Investors purchase these bonds at a steep discount of their face value in the anticipation that the company will successfully emerge from bankruptcy as a viable enterprise.

Private debt also includes specialized strategies, such as CLOs, unitranche debt, real estate debt, and infrastructure debt.

Risk-Return of Private Debt

Investing in private debt is riskier than investing in traditional bonds. It can certainly add diversity to a traditional portfolio because it has less than perfect correlation with those investments. Investors need specialized knowledge to adjust exposures for differences across company funding stages, debt structures, and underlying assets.