Difference Between Private Debt and Private Equity

Edited by Diffzy | Updated on: May 14, 2023

       

Difference Between Private Debt and Private Equity

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Introduction

Private Equity and Private debt are the two different ways of funding a business. Each approach accompanies its arrangement of upsides and downsides concerning financing a business. Let’s look further into this and draw a comparison.

Private Equity vs. Private Debt

It is the source and use of the cash that distinguish private equity from private debt.

With regards to private equity, various financial backers are permitted to put resources into little, developing firms that can be sold later at a more exorbitant cost. The fundamental point is to get enormous scope benefits.

Though private debt, then again, is only a type of credit. This advance can be both formal and casual. The debt wouldn't empower you to make gigantic interests in the organization, and the net revenues are genuinely low. Private debts are generally given by people or an organization, determined by the relationship terms between the borrower and loan boss.

Difference Between Private Equity and Private Debt in Tabular Form

Parameters of comparisonPrivate EquityPrivate Debt
DefinitionPrivate Equity normally means investment funds, normally coordinated as limited partnerships, that purchase and rebuild organizations. A private equity company is an economic resource class that invests in equity securities and debt in companies that are not publicly traded.Private Debt incorporates any debt held by or reached out to privately held companies. It comes in many structures, yet most commonly includes non-bank organizations making credits to privately owned businesses or purchasing those advances on the secondary market.
Role of InterestThese organizations search for youthful firms and underestimated organizations to put resources into, foster them, exchange, and get profit People or private investors provide private debt in the form of credit cards, corporate bonds, or small company loans.
SourcePrivate equity comes from private investors and enterprises aiming to acquire smaller businesses.Private debt can come from a private corporation, a bank, or even friends and family.
Investors' incentivesInvestors are drawn to a business that is gaining traction and making steady sales with strong profits. They invest enormous quantities of money in the hopes of making a large profit if things go their way.Individuals and businesses who lend money to a company aren't necessarily invested in its success. They are motivated by the interest they earn regularly as well as the capital payback they receive after the loan period. They're also aware that if the company goes out of business, they'll get their money first.
Repayment ConditionsPrivate equity investors have less severe cash requirements. If a company is struggling, it is unlikely to pay dividends. If a partner wants to sell their stake, the firm or individual who bought it must repay them.Regular cash or comparable asset payments to the person or company who lent the money are required by debt. This can put a strain on a company's cash flow. Furthermore, unlike private equity, the debt must be repaid within a set time frame.
Impression on the balance sheetOn your balance sheet, equity does not appear as a liability. Other equity holders must be disclosed in your financial and corporate papers.It is a corporation and balance sheet obligation. Investors may be wary of a corporation with too much debt.

What is Private Equity?

According to its name, private equity is the acquisition of private companies not listed on a stock exchange. Private Equity funds are solely concentrated on equity investments.

Private Equity constitutes the investment of money into private companies. Private Equity firms collect money from other companies and wealthy people and the money that has been pulled together is then used for investing in purchases and sales of businesses. It refers to firms that invest in equity of private companies intending to exit at higher valuations in the future.

The focus of private equity firms varies according to the life cycle stage of the targets. Some private equity might be interested in new firms with a high growth outlook and an optimistic management team while others may focus on established companies with stable cash flows and leveraged buyout transactions. It is also possible to notice private equity making investments in distressed companies. The private equity profession is about possessing the skill of making the correct bet on the correct companies and then effectively providing direction to improve their chances of being successful.

Structure of Private Equity Firms

Private Equity Firms are typically structured in two main ways:

1) Limited Partnership: These are much more popular in the United States. Two types of limited partners make up a limited partnership. These are General Partners and Limited Partners.

While General Partners are responsible for the administration and handling of the fund, selecting target companies to invest in, and consulting following investment, Limited Partners are responsible for bringing capital to the table.

The partnership is charged a management fee by the General Partners and they are entitled to be given carried interest. The 2-20% Compensation Structure entails a 2% management fee regardless of whether or not the fund is successful. In partnership agreements, it is sometimes specified that a definite minimum rate of return must be achieved before Carry Interest is owed to General Partners. A limited partner receives the fund's earnings minus what the general partner has received.

2) Closed-end funds: These are essentially utilized in Europe. It normally includes a recently made organization and the financial backers give cash flow to that organization and the administration firm signs an administration contract with the organization. The pay plans remain practically the same under this sort of design and the traditional 2-20% Compensation structure follows.

What is Private Debt?

Private Debt alludes to the arrangement of buyer credits and business advances that financial backers can't access through open business sectors. Examples of public debt assets are Consumer loans such as personal loans credit cards and car loans and Business loans such as invoice financing, unsecured business loans, and supply chain finance.

Private debt refers to when any company raises capital from the capital market in which the transaction generally has covenant features similar to a bank loan but it is not a bank loan and is used as an alternative to bank funding.

Let’s explain private debt using four main categories:

  1. Direct Lending: It refers to private lending to companies in the form of loans as opposed to equity.
  2. Mezzanine Loans: These are set subordinate to senior secured debt but are senior to equity holders so in the event of bankruptcy your senior secured debt would get the first claim on the assets then your mezzanine loans then your equity holders.
  3. Venture Debt: It is a loan to a small company that has low or negative free cash flow. Most of the time this loan will be convertible to equity or have some sort of equity upside.
  4.  Distressed Debt: It is a loan given to a company that may have difficulty meeting its debt covenants or maybe in the process of bankruptcy or is distressed in some way.

What is Private Debt in Terms of a Leverage Buyout?

In a buyout, a lot of times the private equity fund will buy a company in a leveraged buyout, also known as LBO. An LBO uses debt. Now, the question arises of where this debt comes from. Well, there are many levels of debt but traditionally the most senior debt has come from banks. However, after the financial crisis, the banks have had more restrictions hence, we have started to see more

and more private equity firms raising private debt funds so that private equity can provide debt on private equity deals.

Main Differences Between Private Debt and Private Equity ( In Points)

  • Private equity refers to investment funds that buy and restructure businesses, usually in the form of limited partnerships. A private equity firm invests in non-publicly listed companies' equity and debt securities. Whereas, Any debt held by or owed to privately held businesses is classified as private debt.
  • Private Equity firms look for young and undervalued businesses to invest in, nurture, exchange, and profit from. While, people or private investors provide private debt in the form of a credit card, corporate bonds, or a small company loan.
  • Private equity is acquired from private investors and organizations that purchase small firms. On the other hand, public debt can come from a private corporation, a bank, or even friends and family.
  • The cash requirements for private equity investments are less strict whereas, in the case of private debt regular cash or comparable asset payments to the person or company who lent the money are required. In addition, unlike private equity, loans must be repaid within a set timeframe.
  • Private equity does not appear as a liability on a company's balance sheet. However, it must be noted in your balance sheet and other records under other equity. Debt, on the other hand, appears as a commercial liability.

Conclusion

In some ways private debt targets similar companies to private equity. A lot of times it’s the same company just a different part of the capital structure, debt instead of equity.  In contrast to a traditional commercial loan, private debt offers a lot more flexibility. Private equity companies can leverage their relationships with target companies to offer them credit solutions because of this private equity firms have been able to raise private debt funds.  Private debt is similar to private equity where the equity capital is raised from a few select sets of investors instead of raising it from the public. Both private debt and private equity play important roles in the growth and development of new businesses. Both are profit-driven and come with their own set of risks.

References

  • https://www.unpri.org/private-debt/an-overview-of-private-debt/4057.article
  • https://pitchbook.com/blog/what-is-private-debt
  • https://www.investopedia.com/terms/p/privateequity.asp

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"Difference Between Private Debt and Private Equity." Diffzy.com, 2024. Mon. 20 May. 2024. <https://www.diffzy.com/article/difference-between-private-debt-and-private-equity-1157>.



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