Private credit is an asset class of privately negotiated loans and debt financing from non-bank lenders. This includes small business and consumer loans, venture debt and other forms of private debt. Small businesses, startups and individuals seek private credit when they cannot access public credit markets.

Advantages of private credit investing

Investors find private credit investments to be attractive alternatives or additions to traditional investments – stocks, bonds, and beyond.

Private credit provides three major benefits listed below:

1. Short Term: Private credit investments typically have shorter terms ranging from 1 month to 5 years. This provides more liquidity than private equity or venture funds which lock up capital for 10+ years. Shorter durations allow investors to take advantage of rising interest rates or reinvesting capital sooner.
2. Higher Yielding: Interest rates on private credit can significantly outpace traditional fixed income like government or corporate bonds. The higher yields compensate for the greater underlying risk with private credit.
3. Largely Uncorrelated: As fixed income instruments, most private credit have low correlation to the stock market. This provides valuable portfolio diversification benefits. Private credit can hedge against volatility and downturns in the stock market. Given the limited correlation, private credit can improve portfolio risk-adjusted returns.

Understanding private credit types

There are various classes of private credit available to accredited investors and qualifying purchasers.

Consumer Loans are credit instruments issued to individuals rather than institutions or organizations. Common types of consumer loans include credit cards, personal loans, auto loans, and mortgages. These loans allow consumers to finance large purchases or consolidate debt over time. Key metrics used to evaluate consumer borrowers are credit scores like FICO or VantageScore, debt-to-income ratios, and other factors like employment history. Collateral also plays a role – auto loans and mortgages are secured by the vehicle or property while credit cards and personal loans are usually unsecured. Consumer lending has expanded with fintech lenders using alternative data sources and digital underwriting to cater to underbanked demographics.

Trade Receivables refer to outstanding obligations that a business is owed resulting from selling goods or services on credit. One form of trade receivables financing is factoring, which involves purchasing a company’s account receivable or invoices at a discount. The factor provides immediate financing to the business by advancing a portion of the invoice amount, with the balance paid later minus fees after the customer pays. Factoring transfers the risk of slow-paying or non-paying customers from the business to the factoring firm. It provides businesses with improved cash flow and essentially outsources credit management and collections. Factors focus risk analysis on the credit quality of the accounts being purchased rather than the seller. However, factors usually retain full recourse to the selling business in case of non-payment. Industries like transportation, staffing, and manufacturing commonly use invoice factoring to accelerate cash flow between billing cycles.

Small Business (SMB) Loans are short-to-medium term loans and may be secured or unsecured. SMB lending focuses risk analysis on the borrowing firm’s finances rather than the business owner’s credit score. Terms usually range from 1-5 years with both secured and unsecured options. Collateral like equipment, invoices, or guarantees can reduce default risk. Industry-specific SMB lenders use alternative data like online sales or shipping volumes to underwrite niche e-commerce merchants.

Compared to large corporations, SMBs have higher financing costs due to lower transparency and underwriting challenges. But returns can be attractive for investors willing to research individual SMB credits. Overall, SMB loans fill a critical funding gap and fuel job creation by emerging companies not served by banks. SMB lenders take on more opaque risks than consumer credit but can produce solid returns with due diligence.

Small Business (SMB) Cash Advances, also known as merchant cash advances (MCAs), provide financing to small and medium-sized businesses by purchasing a portion of their future receivables. The merchant receives an upfront lump sump payment in exchange for a fixed percentage of their future sales over a set period, usually 4-12 months. Daily repayments are automatically deducted from the business’s receivables until the balance is paid off.

Unlike loans, cash advances do not have set maturities or fixed monthly payments. The open repayment structure makes it easy for merchants to qualify. However, total repayment amounts can end up vastly exceeding the original advance depending on the term length and deducted percentage. Slow revenue periods can significantly extend the payback schedule. The future receivables being purchased can have high risk of underperformance. Extensive due diligence is required for investors to assess merchant health and appropriate advance terms to mitigate default exposure

Small Business (SMB) Leases allow small and medium-sized companies to finance essential equipment like machinery, software and vehicles over time rather than paying large upfront costs. Benefits to investors include portfolio diversification and contractual cash flows protected by the leased assets. Investors take on risk tied to the financial health of the SMB and rely on the ability to reclaim assets in case of default. Lease terms usually range from 2-5 years with the option to renew – providing an advantage over lending where principal is repaid and contracts expire. However, the value of reclaimed assets may depreciate over time if not easily re-leased. Overall, SMB leases can generate stable returns for investors willing to research individual opportunities. For SMBs, leasing preserves capital and provides an alternative to debt financing for acquiring essential equipment.

Getting started with private credit

Private credit can be an attractive option for accredited investors seeking higher yields and diversification from conventional fixed income. The first step is thoroughly researching different private credit strategies to identify optimal risk/return profiles aligned with your investment goals. Many private debt funds have high minimums, so working with a fund of funds or specialized platform like Percent that offers lower investment minimums starting at $500 can provide necessary exposure and diversification.

Evaluate factors like asset class, geographic focus, credit quality, and duration to choose the right funds for you. Understand all risks and fees associated before investing. Consider starting small to test out private credit in your portfolio before increasing allocations. Utilize advisors to conduct due diligence and integrate private credit into a prudent asset allocation.