What is private credit?

Read our guide written with the Alternative Credit Council (ACC).

Also known as private debt, direct lending, or private lending, the funding that private credit managers provide to UK businesses is becoming more and more vital.

According to the Alternative Credit Council, around 2,000 firms in the UK are, in total, receiving an estimated £100 billion from these managers.

Private credit's importance as a source of funding was highlighted in the British Business Bank's recent report, UK Private Debt Research Report 2020.

The report confirmed that, since the 2008 economic crisis, private credit is now a valuable source of finance for smaller businesses across the UK - with a combined total of £18.4 billion of lending in 2018 (£9 billion) and 2019 (£9.4 billion).

For further information, read the Alternative Credit Council's borrower's guide to private credit.

What is it?

Private credit refers to lending which is:

• provided by a lender other than a bank
• tailored to the borrower's specific needs

The lending is usually negotiated directly between the lender and the borrower and tailored to the borrower's specific needs.

The amount involved typically ranges from £10 million to £250 million.

Unlike corporate bonds, for example, private credit is not traded on public markets.

It often matures (becomes due for repayment) after three to seven years, and has a floating (variable) interest rate.

While high-street banks have some appetite for riskier corporate lending, most of their lending tends to be through more standardised products focused on lower risk.

As a result, private debt is often the only, or most viable, funding solution for small and medium-sized businesses that need their financing to be flexibly structured.

Types available

Private credit is available as:

• loans
• bonds
• notes
• private securitisations (a type of asset-backed financing structure)

This page focuses on loans only.

What do typical loans look like?

Asset-based finance

When a business borrows money secured against the value of assets it owns.

Learn more about asset-based lending.

Cash flow finance

When a business borrows money secured against its expected cash flows.

As a result, the business's equity can be considered the collateral (security) of the loan.

Trade finance

This allows borrowers to buy specific goods in both domestic and international markets.

The finance is often transactional, provided only for specific shipments of goods and for specific periods of time.

The debt is secured against the goods being financed.

Real estate finance

When a business borrows money secured against an underlying real estate asset (an investment in property, for example).

Infrastructure debt

Used to finance long-term infrastructure or industrial projects.

The borrower repays the debt using the cash flow generated from the project the lender has financed, once complete.

Rescue finance

Loans provided to companies that have filed for bankruptcy or are very likely to do so in the near future.

Venture debt

Also known as venture lending, this is a loan provided to early-stage venture-backed companies that enables them to proactively finance growth.

What are loans used for?

Borrowers use these loans for a variety of purposes, such as:

• funding plans for acquisition or expansion
• improving working capital
• refinancing

Among the most popular borrowers are small and medium-sized businesses.

However, many firms cater to larger businesses.

Benefits

Growth

Although your business may choose to sell equity as a way of financing its growth, if you're established and profitable you might want to avoid the surrendering of control that equity finance often brings.

Consequently, private credit gives you a wider and more competitive choice of debt finance for expanding and scaling up your business.

For many smaller and mid-sized firms that are looking to be more ambitious in their growth and development, this can often be the key to unlocking their potential.

Flexibility

Some lenders have strong restructuring skills that allow them to provide operational support in challenging economic environments (such as COVID-19).

Direct lending is also well suited to supporting firms in their recovery efforts, and beyond, thanks to its bespoke and adaptable structures.

With many of the UK's small and mid-sized companies having taken out emergency loans to survive the immediate impact of COVID-19, 'debt overhang' (a debt burden so large that it stops the business taking on more) is a key challenge and risk, requiring careful planning and consideration as the economy recovers.

Funded by direct lending, your business may be better able to withstand a contracting economy and take advantage of opportunities for expansion.

Deals are generally structured with a large proportion of 'bullet repayments' (when you pay back the finance in one lump sum at the end, rather than in instalments).

This gives you access to the capital you need to invest in growth, rather than having to meet immediate obligations to repay debt.

Refinancing

Private lending may also be suitable if your business is currently funded through bank lending and has a strong opportunity to grow.

While it may cost you more, it would allow you to replace an existing loan with a structured lending product whose repayment terms are more flexible.

As a result, you can focus on your business's recovery before you think about repaying the loan.

How do lenders decide whether to borrow?

Direct lenders often specialise in specific sectors - for example, agriculture, automotive, retail, healthcare or real estate.

In any case, when you approach a firm for finance, it will do a significant amount of due diligence to identify whether your business is a 'good fit' for its investment.

Generally, there are three key concepts that firms use to assess your business.

EBITDA

A key measure used to gauge a business's financial performance is its earnings before interest, taxes, depreciation and amortisation (EBITDA).

To learn more about what this is and how it works, read our brief guide to EBITDA for small businesses

Leverage ratios

A lender will use these ratios to determine how much debt your business holds against other measures on your balance sheet.

Most importantly, the debt to EBITDA ratio measures your company's ability to repay its debts.

A high ratio may indicate that you're currently too burdened with debt to be able to pay back further loans.

To learn more, read our article: What level of debt is healthy for a business?

Loan-to-value (LTV) ratio

This compares the size of a loan to the value of the asset on which the loan is based.

Additional Information