Private Credit vs. Private Equity: Pros and Cons for Investors

Private markets give investors options beyond stocks and bonds. Two common choices are private credit and private equity. Private credit focuses on lending to companies for interest income, while private equity means buying ownership stakes and working to increase the value of those businesses. Understanding these two approaches, along with their risks and rewards, can help you decide which is a better fit for your long-term financial goals.

For more hands-on help, a financial advisor can review your portfolio, assess risk tolerance and determine how private credit and private equity align with your overall strategy.

What Is Private Credit?

Private credit refers to lending that takes place outside the traditional banking system and public bond markets. Instead of borrowing from a bank or issuing debt on an exchange, companies raise capital directly from private lenders, such as asset managers, private funds or institutional investors.

At its core, private credit is a direct lending arrangement. A private lender provides a loan, often to a mid-sized or private company, that may not have access to public markets. These loans can take different forms depending on the company’s needs and risk profile. Because these arrangements are negotiated privately, their repayment schedules, covenants and interest rates are customizable.

Pros and Cons of Investing in Private Credit

For investors, private credit can offer attractive income potential compared with traditional fixed income products. Yields are often higher because borrowers are willing to pay more for the flexibility and speed that private lenders provide. In addition, the loans are generally floating-rate. This means they can adjust with rising interest rates, something that may appeal in today’s economic environment.

Let’s take a look at the of the pros and cons for investing in private credit.

Pros of Investing in Private Credit

Higher yields: Private credit often provides higher interest payments than traditional bonds, compensating investors for the additional risk and illiquidity.
Diversification benefits: Because private credit is not tied directly to public markets, it can help spread risk and reduce reliance on stocks or government bonds.
Floating-rate potential: Many private credit loans adjust with interest rates, which can help protect returns in a rising-rate environment.
Customization: Loans are negotiated directly, allowing for tailored terms that may better align with investor goals.

Cons of Investing in Private Credit

Illiquidity: Unlike publicly traded bonds, private credit investments are harder to sell quickly, often requiring multi-year commitments.
Credit risk: Borrowers are frequently mid-sized or private companies, which may have a higher chance of default compared with larger, publicly traded firms.
Limited transparency: Private credit deals occur outside public markets, meaning less information is available for investors to evaluate.
Higher barriers to entry: Many opportunities are only available to institutional or accredited investors due to regulatory and risk considerations.

What Is Private Equity?

Private equity refers to investments made directly in private companies—or public companies that are taken private—with the goal of improving their value and later selling them at a profit. Unlike private credit, which is debt-based, private equity involves ownership stakes. Firms raise capital from institutional investors and high-net-worth individuals, then puts those funds into businesses across various industries.

The investment strategy typically involves acquiring a controlling interest in a company, restructuring its operations and pursuing growth initiatives. Private equity firms often aim to increase efficiency, cut costs, expand product lines or enter new markets. Once the company’ss value has grown, the firm may exit the investment through a sale, merger or initial public offering (IPO).

Pros and Cons of Investing in Private Equity

Private equity can deliver high growth but comes with high risk, long lockups and high fees.

For investors, private equity offers the potential for substantial long-term returns. The asset class has historically outperformed public equities over extended periods, largely because of its active management and hands-on approach. Private equity also offers investors the opportunity to participate in companies and strategies that aren’t available in public markets.

Here is a closer look at the pros and cons of investing in private equity.

Pros of Investing in Private Equity

Potential for high returns: Historically, private equity has outperformed public markets over the long term, offering the chance for significant gains.
Access to unique opportunities: Investors can participate in businesses and growth strategies that aren’t available in traditional public markets.
Active management: Private equity firms often take a hands-on role in improving operations, driving growth and unlocking value.
Long-term focus: With investment horizons of five to 10 years, private equity allows companies to make strategic changes without the short-term pressures of public markets.

Cons of Investing in Private Equity

Illiquidity: Investors typically must commit capital for many years, with limited options for early withdrawal.
High risk: Returns depend heavily on the firm’s ability to execute its strategy and improve the target company’s performance.
Significant capital requirements: Many private equity funds require large minimum investments, making them less accessible.
Limited transparency: Because private equity deals happen privately, investors often have less information and fewer protections compared with public markets.

Key Differences of Investing in Private Credit vs. Private Equity

Private credit and private equity are both part of the private markets, but they operate in fundamentally different ways. One provides debt financing while the other takes ownership stakes. Each comes with its own opportunities and challenges. Understanding how they differ can help investors decide which, if either, fits into their portfolio.

Private Credit

Involves lending money to private companies, usually through customized loan agreements.
Generates returns primarily through interest payments rather than company growth.
Often features floating interest rates, which can adjust in line with rising rates.
Typically has shorter investment horizons than private equity, though may still tie up capital for several years.

Private Equity

Involves taking ownership stakes in companies, often with a controlling interest.
Seeks returns through growth, restructuring and eventual sale or IPO of the company.
Requires longer holding periods, usually five to 10 years or more.
Offers potentially higher returns but carries greater execution and market risk.

In short, private credit focuses on lending and steady income, while private equity centers on ownership and long-term growth potential. Both require patience and a tolerance for illiquidity, but they appeal to different investor goals. For those considering these asset classes, working with a financial advisor can provide guidance on how private credit or private equity may complement an overall investment strategy.

Bottom Line

Private credit provides income, while private equity targets growth, and both require long-term commitment with higher risks.

Private credit and private equity can both be part of a portfolio, but they serve different purposes. Private credit is mainly about steady income from loans, while private equity focuses on long-term growth by owning and improving businesses. Both carry risks like being hard to sell and needing years of commitment.

Investment Planning Tips

A financial advisor can help you determine how private credit could add income to your portfolio and how private equity could add growth. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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