Private credit vs private equity

Capital structure, return profiles, senior secured mechanics, and what each form of capital means for a company taking the money.

Private credit and private equity are both forms of privately raised capital, but they occupy fundamentally different positions in a company's capital structure. One is debt; the other is ownership. The distinction matters enormously for the companies that take the money, because it determines who controls what, who gets paid when, and what happens when things go well or badly.

For borrowers, founders, and management teams evaluating their options, understanding these differences is not academic. It shapes the kind of company you will be for the duration of the capital relationship.

What is private credit?

Private credit is lending that happens outside the public bond markets and the traditional banking system. A private credit fund raises capital from institutional investors and lends it directly to companies, typically as senior secured loans. The fund earns its returns from interest and fees, and the borrower retains full ownership of the business.

The loans are structured with covenants — contractual conditions the borrower must maintain — and secured against the company's assets. This gives the lender downside protection without needing to own the business. The borrower's obligation is to service the debt according to the agreed schedule and stay within the covenant framework.

What is private equity?

Private equity is ownership capital. A private equity fund acquires equity stakes in companies, typically through leveraged buyouts, growth equity investments, or recapitalisations. The fund earns its returns by increasing the value of the business and eventually selling its stake, whether through a trade sale, a secondary buyout, or an IPO.

Taking private equity capital means giving up some or all of the ownership of the business. It also means accepting new governance: board seats, reporting requirements, strategic influence, and alignment around an exit horizon that typically runs three to seven years.

Where does each sit in the capital structure?

The capital structure is the stack of claims on a company's assets and cash flows, ordered by priority. Understanding where each form of capital sits in this stack explains most of the differences in how they behave.

Senior secured debt sits at the top. It has the first claim on the company's assets if something goes wrong, and it gets paid first from the company's cash flows. Most private credit lending is senior secured: the loan is backed by specific collateral — property, equipment, receivables, shares in subsidiaries — and the lender has a first-priority security interest in those assets.

Subordinated debt (mezzanine, second-lien, unitranche with subordinated tranches) sits below senior debt. It has a lower claim on assets and cash flows, which means more risk for the lender and, accordingly, higher pricing.

Equity sits at the bottom. Equity holders have the last claim on assets — after all creditors have been paid — but they capture all the upside above the debt service obligations. This is the trade-off: equity bears the most risk but has unlimited upside, while senior debt has the least risk but capped returns.

This hierarchy is not theoretical. It determines who gets paid first in a restructuring, who has leverage in a negotiation, and whose interests the company's management is most immediately accountable to.

How do return profiles compare?

Private credit and private equity earn returns in fundamentally different ways, and this shapes the incentives of each.

Private credit returns are contractual. The interest rate and fee structure are agreed upfront. The lender knows, within a range, what its return will be if the borrower performs. Returns are typically expressed as a spread over a reference rate (SONIA, EURIBOR) and are realised through regular cash interest payments over the life of the loan. The lender does not participate in the business's growth beyond receiving its scheduled payments.

Private equity returns are contingent. The fund's return depends entirely on how much it can increase the value of the business and what price it achieves on exit. Returns are realised in a lump sum at exit rather than through regular income, and they can range from total loss to many multiples of the original investment. Private equity funds typically target returns well above what a credit fund expects, but they accept commensurately higher risk and a longer, less predictable path to realisation.

For the company in the middle, this difference in return mechanics translates into a difference in what each capital provider cares about. The credit fund cares about downside protection — will the company generate enough cash to service the debt and maintain its covenants? The equity fund cares about upside capture — how fast can the business grow, and what will it be worth at exit?

What does each mean for a company taking the money?

The practical implications for a company are different enough that the choice between private credit and private equity often comes down to what the owners are willing to give up.

Ownership and control. Private credit preserves both. The existing owners retain their equity, their board seats, and their strategic autonomy. The lender's controls are exercised through covenants — financial thresholds and operational restrictions built into the loan agreement — rather than through governance rights. Private equity, by contrast, typically requires the fund to take board representation and significant influence over strategic decisions, hiring, capital allocation, and the exit process.

Dilution. Borrowing from a private credit fund creates no dilution. The existing owners retain their full share of any future appreciation in the business. Taking private equity capital reduces the existing owners' share, often substantially.

Cash flow obligation. Debt must be serviced. The company must make interest payments and, usually, scheduled principal repayments regardless of how the business is performing. Equity has no such obligation; dividends are discretionary, and there is no repayment schedule. For a business with strong, predictable cash flows, the debt service burden is manageable. For a business with volatile or uncertain cash flows, equity may be more appropriate.

Time horizon. A loan has a stated maturity. The borrower knows when the obligation ends. An equity investment, by contrast, introduces an exit dynamic: the private equity fund needs to sell its stake within a defined period, and the company's strategy will be shaped by that horizon whether the timing is ideal or not.

How do senior secured mechanics work?

Most private credit lending — and certainly the kind that direct lenders in the UK and Europe focus on — is structured as senior secured debt. The mechanics of how this works are worth understanding, because they define the relationship between borrower and lender.

Security. The borrower grants the lender a security interest in specified assets: real property, equipment, receivables, intellectual property, shares in subsidiaries, or sometimes the entire business as a going concern. This security interest is registered and gives the lender priority over other creditors in the event of a default. The strength and coverage of the security package is a core part of the underwriting process.

Covenants. The loan agreement will include financial covenants — minimum coverage ratios, maximum leverage ratios, limits on capital expenditure or distributions — and operational covenants that restrict certain actions without lender consent (selling material assets, taking on additional debt, making acquisitions above a threshold). Covenants are a monitoring tool: they give the lender early warning if the business is drifting from the plan, and they create a framework for a constructive conversation before problems become acute.

Priority in distress. If a company encounters financial difficulty, the priority of claims matters. Senior secured creditors are paid first from the proceeds of any asset realisation, before subordinated creditors and before equity holders. This priority is why senior secured debt carries lower risk than mezzanine or equity, and why it is priced accordingly. It also means that in a restructuring, the senior secured lender is the most important counterparty at the table.

Enforcement. If a borrower defaults on its obligations, the senior secured lender has the right to enforce its security — to take control of the collateral and realise value from it. In practice, enforcement is a last resort. Most private credit lenders prefer to work with borrowers to find solutions, because a negotiated outcome almost always produces a better recovery than a forced realisation. The existence of security, however, shapes the dynamic: the lender's ability to enforce gives it leverage to insist on remedial action.

Choosing between them

The choice between private credit and private equity is not always binary. Many transactions involve both: a private equity sponsor acquires a business and finances part of the purchase with debt from a private credit fund. In that structure, the company has both equity owners and debt holders, each with different rights, different priorities, and different incentives.

For a company considering its options independently, the guiding questions are straightforward. Can the business comfortably service debt? Do the owners want to retain control? Is there a clear use of proceeds that generates returns above the cost of borrowing? If so, private credit is likely the better fit. If the business needs more capital than it can support as debt, or if the owners are seeking a partner with operational expertise and an aligned exit incentive, private equity may be the right path.

Either way, understanding what each form of capital asks of you — and what it gives you in return — is the starting point for a good decision.