Advisor takeaway
"Private credit" is a category, not a strategy. Where a loan sits in the capital structure and the borrower’s size tell an advisor more about risk than the asset class label ever will.
A working definition
The Federal Reserve defines private credit as loans "negotiated on a bilateral basis between borrowers and lenders" by nonbank institutions.4 Three features follow from this definition.
The loan is negotiated rather than syndicated to a broad group of buyers, so the terms are bespoke and the lender retains information rights. The loan is held, usually to maturity, so the originator bears the credit risk rather than distributing it. And the loan is private, so it is neither publicly rated nor continuously priced, which is both the source of the illiquidity premium and the reason valuation deserves its own scrutiny (Chapter 7).
Why private credit scaled
Two explanations circulate, and the evidence supports both operating together. The supply-side story is familiar: post-2008 bank capital rules and leveraged lending guidance pushed middle-market lending off bank balance sheets.
The demand-side story is newer and matters for anyone assessing durability. Research from the Bank for International Settlements, published in September 2026, finds that borrower demand, particularly from technology firms, drove much of the post-2020 growth and concludes that "a relaxation of bank regulation alone is therefore unlikely to materially reverse private credit's growth."8 Private credit is not simply regulatory arbitrage waiting to be undone.
The capital structure stack
Every question about credit risk begins with position. When a borrower cannot pay everyone, the capital structure determines who is paid first.
Figure 1: The corporate capital structure: where private credit sits
Repayment priority: paid first to paid lastRisk and expected return rise toward the bottom
FIRST▼LAST
Revolver / super-senior
Working capital, first out
First-lien senior secured
First claim on collateral
Unitranche
Senior and junior blended into one loan
Second-lien
Secured, paid after first-lien
Mezzanine / subordinated
Unsecured, often with equity warrants
▲ PRIVATE CREDIT LENDS HERE · PRIVATE EQUITY OWNS HERE ▼
Preferred equity
Ownership, ahead of common
Common equity
Residual claim, paid last
The corporate capital structure, from the safest and lowest-yielding claims at the top to the most subordinated at the bottom. Private credit strategies occupy the debt layers. Private equity occupies the bottom.
Seniority is the single most important protection in lending, and it is not a matter of degree. A first-lien lender is repaid in full before a second-lien lender receives any payment. Yield rises as a claim moves down the stack precisely because the risk of impairment increases.
Definition: first-lien and senior secured
A lien is a legal claim on specific assets. A first-lien lender has the first claim on the borrower's pledged collateral. "Senior secured" means the claim ranks ahead of other debt and is backed by assets. Together, these terms describe the strongest standard position a corporate lender can hold.
The strategy taxonomy
| Strategy | Where it sits | Typical borrower | Main return driver | Main risk |
|---|
| Senior direct lending (first-lien) | Top of the debt stack | Middle-market company, often sponsor-backed | Contractual interest | Borrower default, with collateral recovery |
| Unitranche | Blended senior and junior in one loan | Middle-market borrower wanting one lender | Blended interest rate | Junior portion absorbs loss first in practice |
| Second-lien | Below first-lien, still secured | Larger leveraged borrower | Higher spread | Paid only after first-lien is made whole |
| Mezzanine / junior capital | Below secured debt | Borrower needing capital beyond senior capacity | High coupon, sometimes equity warrants | Unsecured; severe loss in default |
| Asset-based lending / specialty finance | Secured by specific assets | Companies with receivables, inventory, equipment | Interest plus collateral control | Collateral valuation and servicing |
| Opportunistic / distressed credit | Varies, often bought at discount | Stressed or defaulted borrower | Price discount and restructuring outcome | Timing, legal process, total loss risk |
| Venture debt | Senior to equity, junior in practice to cash runway | Venture-backed company | Interest plus warrants | Borrower may have no profitability at all |
| Real estate debt | Secured by property | Property owner or developer | Interest plus collateral | Property value and refinancing risk |
| NAV lending | Secured by a fund portfolio | A private fund, not an operating company | Interest | Underlying portfolio value and fund governance |
A fund described as a "private credit fund" may be pursuing any of these. Advisors should be able to state, in one sentence, which rows of that table a given fund occupies and the proportion.
Market segmentation: where the borrower sits
Borrower size changes nearly everything about a loan: the number of lenders competing for it, the covenant package, the pricing, and the borrower's leverage.
| Lower middle market | Core middle market | Upper middle market and large cap |
|---|
| Borrower EBITDA (approximate) | Under about $25 million | About $25 to $50 million | Above $50 million, often well above |
| Competition for the deal | Fewer lenders, relationship-driven | Moderate | Intense, including the syndicated market |
| Covenant package | Maintenance covenants largely intact | Mixed | Frequently covenant-lite |
| Pricing | Wider spreads | Moderate | Tightest spreads |
| Lender leverage in a workout | High; often the only lender | Moderate | Lower; more lenders at the table |
| Overlap with public markets | Minimal | Some | Substantial; borrowers can refinance publicly |
The segment distinction has emerged as one of the more consequential findings in recent independent research. Cambridge Associates reports that lower-middle-market and specialty lenders "have largely maintained covenant discipline," while the upper middle market "has long accepted the absence of financial maintenance covenants."7 Competition was concentrated at the large end of the market, and so was the erosion of lender protections.
A second distinction cuts across size. Sponsor-backed borrowers are owned by a private equity firm, which brings professional governance, reporting discipline, and an equity owner with capital and reputational incentives to support the company. Non-sponsored borrowers lack that, so diligence is heavier and the lender is more alone in a workout. Neither is inherently better, but a fund's mix of the two reveals a great deal about how it underwrites.
Two funds can both be called senior direct lending and still operate in different businesses.
Key takeaway
Before asking what a private credit fund yields, establish three things: where in the capital structure it lends, how large its borrowers are, and what share of its portfolio is sponsor-backed. Those three answers explain most of the risk difference between any two funds in the category.
