Private Credit Funds: Understanding Structure and Strategies

A private credit fund pools money from investors and uses it to provide financing to borrowers, such as companies or asset owners, or to purchase loans and receivables. Instead of owning a share of a business, the fund generally holds a creditor position, where the borrower agrees to repay under the terms of a loan agreement.

Three strategy families come up often. Direct lending funds make loans straight to businesses. Asset-based lending funds lend against specific collateral, such as receivables, inventory or equipment. Specialty finance funds focus on niche areas of lending or financing that banks or public markets may serve less often. Each has its own sources of risk, documentation and timelines.

Most private funds are organized as limited partnerships or similar entities. Investors are limited partners, and a general partner or manager makes the decisions. Governing documents, usually a private placement memorandum, a partnership agreement and a subscription agreement, set out fees, terms, investor rights and how and when money can be withdrawn. Many are offered under SEC Regulation D, and investors are often required to be accredited.

Historically, companies and asset owners borrowed mainly from banks or by issuing public bonds. Private lending developed alongside these markets, and funds later became a way for investors to pool capital for loans negotiated directly with borrowers.

Investors have commonly approached private credit as one part of a broader portfolio alongside other asset types. Many compare strategies by looking at what is being lent against, the borrower types, loan terms, how the manager sources and monitors loans, and how the fund handles borrowers who struggle to repay.

Traditionally, access has been limited to institutions and certain individuals. Offerings are typically made under Rule 506(b), which prohibits general solicitation, or Rule 506(c), which allows general solicitation but requires all purchasers to be accredited and the issuer to take reasonable steps to verify that status. Under Rule 501(a), accredited investors include certain individuals meeting income or net worth tests, holders in good standing of Series 7, 65 or 82 licenses, knowledgeable employees of a private fund, and certain entities, family offices with over $5 million in assets or investments, registered investment advisers and exempt reporting advisers. Spousal equivalents may count toward joint tests.

The right independent fund manager may help you understand how a particular strategy actually works, in plain language. A first conversation is generally educational: the manager may describe their approach to lending, the types of collateral or borrowers involved, and how the fund is organized. Whether any offering is appropriate for you is a separate question, which only you and your own advisers can answer.

Useful questions to ask include: What does the fund lend against, and how is that collateral valued and monitored? How are fees and expenses charged? What are the terms for withdrawing money, and could access be limited or delayed? How does the manager handle loans that go wrong? What conflicts of interest exist, and how are they managed? What reports will I receive, and will I receive a Schedule K-1?

It also helps to ask to see the offering documents and read them carefully with your own attorney, tax professional and financial adviser. Past performance does not guarantee future results, so a thoughtful manager should be willing to discuss risks as openly as potential benefits. Any offering is made only by the issuer through its own offering documents.