1.2.7 Private Credit

Welcome to On Judgement. A company wants funding quickly and accepts a higher interest rate for flexible terms. Is that necessarily a bad decision for the borrower or a good one for the lender? Take a first view. You can change it when you have considered the evidence.

Private credit includes negotiated lending and related strategies outside conventional public bond issuance. Borrowers can be private or public companies. Direct lending, asset-based lending, mezzanine, distressed and venture debt have different exposures. A loan may transfer between investors under constraints; private does not mean it can never be sold. Lenders seek interest, fees and repayment rather than the ordinary shareholder’s residual ownership outcome. Some structures include warrants or other equity participation. Venture debt is therefore not universally non-dilutive. A senior loan to a fragile company is not automatically safer than equity in a different, resilient business.

A term sheet describes proposed terms, with binding status depending on its wording and context. Examine amount, currency, tenor, repayment, fixed or floating interest, reference rate, spread, fees, security and ranking. Read financial covenants alongside the definitions used to calculate them. Negative covenants can restrict actions such as additional borrowing or distributions. Financial covenants can set tests such as leverage or interest coverage. A breach may lead to negotiations or contractual remedies rather than immediate full repayment. Security has value only if the claim is enforceable and assets can be recovered on useful terms.

A floating loan’s interest can reset with a reference rate plus a spread, sometimes with floors or caps. It may reduce some interest-rate sensitivity for the lender relative to a similar fixed-rate claim. But higher interest burdens can weaken the borrower’s cash coverage and increase default risk. Analyse the whole capital structure and cash flow under stress. EBITDA is not cash available for interest in every period. Refinancing, working capital, capital expenditure and repayment schedules can matter. Do not infer low risk from infrequent reported valuation changes or a high stated coupon.

A borrower may value a bespoke structure, execution certainty or a relationship with a smaller lender group. Bank loans and public debt can also be flexible in some settings. Price, speed, disclosure, covenant restrictions and financing alternatives must be compared rather than assigned by rigid labels. An investor may accept limited liquidity in exchange for access to negotiated exposures and terms. The return is uncertain and fees matter. Fund redemption arrangements must be compared with the time needed to realise loans. Valuation estimates, concentration, defaults and workout resources are material parts of diligence.

Let's work through The interest reset and coverage. A fictional business borrows £5m at a reference rate of 3% plus a 5% spread. Interest is cash-pay for a full year. EBITDA is £1m. The reference then rises to 5%. Ignore fees, amortisation, floors, tax and other interest. Pause here and try the calculation or reasoning before continuing.

Initial annual rate: 3% + 5% = 8%; interest = £400,000. Initial simplified EBITDA/interest coverage: £1m ÷ £0.4m = 2.50×. New rate: 5% + 5% = 10%; annual interest = £500,000. New simplified coverage = £1m ÷ £0.5m = 2.00×. Interest rises £100,000.

The lender’s higher contractual income comes with a greater borrower burden. Coverage is an analytical ratio, not proof that all payments can be met from cash.

Now try the choices in this lesson. If your answer changes, identify the reason. Explain how floating interest, covenants, collateral and liquidity affect lender and borrower. Use the case activities to put the idea into your own words, and return to the evidence when more than one conclusion is defensible.