Outline the main types of private debt
The idea
Private debt covers direct lending to companies too small or too complex for the syndicated market, mezzanine debt that sits between senior loans and equity and often carries warrants, venture debt lent to young companies alongside equity rounds, and distressed debt bought at a discount in expectation of restructuring. Returns come from a spread over the risk-free rate that compensates for illiquidity and credit risk, and most direct lending is floating rate, so the exposure is to credit rather than to duration.
A practice question
Where does mezzanine debt rank in a company's capital structure?
- Senior to all other debtWhy not: It ranks behind the senior lenders, which is why it is priced more like equity.
- Between senior debt and equity — correct
- Equal with common equityWhy not: It sits above the equity and is paid before it in a default.
It is subordinated to senior lenders but ranks ahead of equity, and its return often includes an equity component such as warrants to compensate for that position.
A harder one
Why does most direct lending expose the investor to credit risk rather than duration risk?
- Because the loans are usually floating rate — correct
- Because private loans have no stated maturityWhy not: They have defined maturities; it is the floating coupon that removes the rate sensitivity.
- Because private borrowers are investment gradeWhy not: They are generally below investment grade, which is why the credit risk is the dominant exposure.
A floating coupon resets with the reference rate, so the loan's value is insensitive to the level of rates and price moves reflect the borrower's creditworthiness rather than the yield curve.
The hardest tier
What distinguishes distressed debt investing from other private debt strategies?
- It lends new money to investment grade borrowersWhy not: Describes the safest end of direct lending rather than distressed investing.
- It is always senior securedWhy not: Distressed investors buy across the capital structure, and the security depends on what is available.
- It buys existing obligations at a discount — correct
The return depends on the restructuring outcome. The investor is not underwriting a new loan but taking a view on recovery, so legal process and bargaining position matter as much as the borrower's operating prospects.
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