Published on
For a long time, financing a growing business or a major property project almost always went through the bank: the entrepreneur handed in a thick file of projections and waited for the credit committee’s verdict.
That division of roles has changed. After the financial crisis, capital rules for banks became stricter (Basel III and its later tightening). For certain types of credit, such as loans to SMEs, acquisitions or specialised property and infrastructure projects, banks now have to hold more capital, and they have become more cautious.
Companies, meanwhile, still need capital to invest, acquire, develop property or grow. Part of that financing now comes from private debt (also called private credit): loans from parties other than banks, negotiated directly with the company or project developer. Globally, it has been one of the fastest-growing asset classes of the past decade.
What is private debt, and why do companies choose it?
Private debt consists of loans agreed directly between a lender, such as an investment holding, a family office or a specialised fund, and a company or project developer, without issuing listed bonds. It is by no means limited to large companies: SMEs and mid-sized businesses use it too.
Why would a healthy company choose such a loan instead of a bank loan? Three reasons come up often:
- Speed and certainty of execution: a syndicated bank loan or a bond issue can take months. Anyone who has to decide quickly on an acquisition or a building plot benefits from a lender who examines the file itself and can decide within weeks.
- Tailoring: banks work with standardised criteria. If a company or project has an unusual cash-flow profile, they sometimes walk away. A private lender can agree a repayment schedule, a grace period or staged drawdowns with the entrepreneur that match how the business actually runs.
- Confidentiality: because the loan is an agreement between the company and one or a few lenders, strategic plans remain confidential.
Two cornerstones: maturity and security
With shares, the return depends on future valuations. With a loan, the return is set out in a contract. Every well-structured loan rests on two pillars.
1. Clear agreements on maturity and interest
Before any money is paid out, both parties fix the term. It can range from a few months for a bridge loan to several years for a property development or a growth plan. During that period, the borrower pays an agreed interest rate, fixed or floating (for example above Euribor). Because these loans are not traded on an exchange, the interest is usually higher than on comparable listed bonds: compensation for the limited liquidity. There is also no daily market price, but that does not mean the risk disappears.
2. Security and terms that limit the risk
A professional lender does not lend blindly. When the loan is drawn up, protective clauses and security are agreed:
- Priority over shareholders: in the order of repayment, debt comes before equity. If things go wrong for the company, creditors are paid first, although full repayment is never guaranteed.
- Mortgage and pledge: with secured loans, the lender gets a first-ranking mortgage or a pledge on specific assets, such as property, land, machinery, inventory or trade receivables.
- Covenants and share pledges: financial conditions, such as minimum cash-flow coverage or a maximum debt ratio, act as early warnings. Together with a pledge on shares, they allow the lender to step in in time.
Four forms of private debt
Depending on the desired risk, a loan can sit at different places in a company’s financing structure:
| Form | Position | Typical security | Risk and return |
|---|---|---|---|
| Senior secured loans | At the top: repaid first | First-ranking security on assets, property or cash flows | Lowest risk among debt types, with correspondingly lower interest |
| Asset-backed loans and project finance | Tied to a ring-fenced project or asset | Property, logistics, equipment or energy infrastructure | Low to medium, heavily dependent on the value of the collateral |
| Unitranche loans | Senior and subordinated in a single loan from one lender | Security over the company as a whole | Blended interest, higher than pure senior debt |
| Subordinated and mezzanine loans | After senior debt, before shareholders | Second-ranking security, guarantees, sometimes a right to shares | Higher interest to compensate for the subordinated position, and higher risk |
The risks of private debt
Even with a good contract and strong security, lending remains a risk:
- Default: a borrower can get into difficulty and fail to repay interest or capital (in full).
- Value of the collateral: property, machinery or inventory may fetch less than expected when sold.
- Enforcement takes time and money: calling on security goes through legal procedures that can take a long time.
- Limited liquidity: a loan usually cannot be sold early; the money is tied up until maturity.
- Concentration and interest rates: a limited number of loans carries a lot of risk, and changes in market rates affect attractiveness and refinancing.
Private debt and private equity: two sides of the same economy
Private debt and private equity both invest in the unlisted economy, but play opposite and complementary roles:
- Private equity sits at the bottom of the financing structure. It takes entrepreneurial risk in exchange for uncapped long-term potential, but returns often take years to come through.
- Private debt sits higher in the structure. Its return is capped at the agreed interest, but there is a fixed term, regular interest payments and, where agreed, security.
Being able to offer both gives entrepreneurs more options. Sometimes a founder does not want to dilute their stake further, or a scale-up needs a subordinated loan to unlock a larger bank facility.
The six domains together
| Domain | Role in the portfolio | Main source of return | How risk is limited |
|---|---|---|---|
| Class A funds | Broad, low-cost core through leading indices | Earnings growth of companies worldwide | Diversification across thousands of companies |
| Automated trading | Rules-based, active strategies | Short-term price movements | Fixed rules, stop-losses and limits, under human supervision |
| International real estate | Geographic diversification and rental income | Rent and changes in value | Tangible assets in several countries |
| Commodities | Counterweight to inflation and supply-chain pressure | Scarcity and demand for raw materials | Different drivers from shares and bonds |
| Private equity | Long-term value creation | Growth of unlisted companies | Board involvement, experience and network |
| Private debt | Contractual income | Agreed interest | Priority, fixed term and security |
How we see it
At Vermeeren & Van Haute, private debt is one of the six domains in which we invest for our own account. We provide loans to companies and projects outside traditional bank financing, with clear agreements on term, interest and security, after thorough research into the borrower and the project.
This article contains general information and is not investment advice, an offer or a recommendation. Lending involves risks, including default and the (partial) loss of the capital lent; security does not guarantee full repayment. Past returns are no guarantee of future results.