Traditionally, private credit has been viewed as “easy money” since (unlike private equity) the investment doesn’t rely on growth to become profitable. Private equity, on the other hand, is frequently seen as high risk — especially during times of economic recession. Consequently, limited partners (LPs) and general partners (GPs) often round out their portfolio with lower-risk private credit deals.

Recently, however, there’s been disruption and churn in the market: Although many public pension funds are pulling away from private equity due to risk, private equity firms are still experimenting with new investment strategies. Some firms are even linking themselves to government contracts by rapidly acquiring defense contractors. Meanwhile, in 2023, investments in private credit surged 89%. Even conservative lenders are changing their investment blends in response to this shift in risk tolerance.

Because each individual deal is unique, LPs and GPs must look at both the individual asset and the broader economic spectrum when balancing their portfolios. In this article, we’ll share how to explore your options between private credit and private equity, and how to understand the differences.

Determining your style of dealmaking

Private credit dealmakers finance an organization’s debt, whereas private equity dealmakers purchase a stake in the organization. Some deals will involve both equity and credit, such as a stake in an organization that includes a revolving line of credit.

Whether you’re a GP managing funds or an LP investing your dollars, chances are you’ll broker both types of deals. But just how many high-risk deals you engage in will depend on your style of dealmaking and your personal risk tolerance.

Many LPs, GPs, and institutional investors worry about being locked into a deal with no available liquidity when other opportunities arise — or when a financial crisis or recession occurs, which would fundamentally make growth plays (equity) a bad bet.

However, keep in mind that risk isn’t static. For example, Silicon Valley Bank invested primarily in long-term bonds (historically an incredibly low-risk asset class) and still collapsed in March 2023.

Because both private and public markets are shifting, you may wish to reexamine the way you approach deals. Historically high-risk dealmakers may find themselves investing in private equity real estate, even though real estate has historically been fairly low risk. Low-risk dealmakers may start moving into private debt and other alternative investments, as the higher interest rates now safely mitigate the potential for default.

Private credit deals: Financing debt

Private credit dealmakers know how much money they’re going to make from a deal, which reduces the risk of their investments. Although there’s virtually no chance of them making more money than anticipated, they at least have peace of mind knowing they won’t make less (unless, of course, the company folds altogether).

Debt markets tend to grow during a recession, and direct lending rises as both individuals and businesses seek additional capital. But this doesn’t mean that investors should go all in on private credit funds instead of private equity funds: If the market crashes, then so will debt markets.

Private credit deals are short term, high interest, and flexible. As a dealmaker, you’ll want to invest in private credit deals if you’re interested in the following:

Fast liquidity — Frequently, dealmakers will loan to a term and get paid back at the end of that term. They may also have opportunities to pull out of a deal, such as recapitalization. Essentially, it’s easier to sell debt than it is to sell equity because the value of the debt is written in stone. There’s already a growth in the secondary private credit market where people can sell their stake in private debt funds or private credit investments to others for liquidity.
High interest rates — As interest rates continue to go up, so does the value of private credit. If you think rates will fall in the future, you may want to take these deals now and lock in historically high interest rates.
Short-term investments — If you don’t think the company will grow over time, or if it doesn’t work with your other portfolio companies, you don’t need to worry about any commitments to companies that won’t fit long term. Since you aren’t tying yourself to owning equity in an organization, you won’t be left holding the bag.

Private equity deals: Purchasing a stake

Private equity dealmakers are stakeholders who can intervene and play an active role in an organization’s success. These dealmakers don’t necessarily know how much profit they’re going to make, but they have more control over the organization.

Private equity deals tend to be more complex and difficult to spin up: You need to pay attention to capital structure and cash flows, do your due diligence, and dig deep into the organization’s finances. Still, private equity has a better chance of paying off big, as valuations can soar with the right guidance.

Private equity deals are longer term than private credit deals; they’re also part of a larger whole and dealmakers are often able to control the outcome. Dealmakers should invest in private equity deals if they’re interested in the following:

Investing long term— If you feel that an organization is a long-term play (i.e., it will gain value over time), it may be a better private equity play. Just as you can flip private equity quickly, you can also hold it.
Improving the company’s value — If you feel that the organization can benefit from your knowledge and resources, you can acquire a stake, improve the asset, and then sell it.
Building synergy between the company and your existing portfolio — Purchasing private equity puts an organization in your portfolio. If the asset fits with the other assets you own, you can build synergy between them. For instance, a company that produces construction software solutions can help support a construction and development company.

Diversifying between equity and debt

There’s always a right answer when it comes to investing, but it’s usually only visible in hindsight. All dealmakers can do is make intelligent decisions based on the information and investment opportunities they have — and make sure that they don’t lean too far in a direction that doesn’t mesh with their current risk profiles.

Most dealmakers already invest in a mix of private credit and equity suited to their needs. If you believe in the long-term strengths of an investment, it’s an equity play. If you need liquidity and short-term gains, it’s a private credit investment.

But no investment decision is made in a vacuum: All investment advice must be tailored to a dealmaker’s current portfolio. Dealmakers also shouldn’t rely on past performance — especially during this current volatile market — as past performance has never been indicative of future results. Instead, private equity firms and credit managers should keep an eye on the news and be aware of how the market is shifting.

Managing your entire portfolio in a single cloud

Whether you’re a GP or an LP, you need to maintain a holistic view of your investments; otherwise, you can’t correctly assess the risk of any individual deal. DealCloud makes it possible to manage your entire portfolio and deal pipeline within a single system:

Analyze — Assess your deals both individually and in context with DealCloud’s deal management pipeline. DealCloud tracks each deal from your initial inquiries to managing your full portfolio, so you have a complete view of the options available to you.
Build — Develop relationships with prospects that will lead to better and more timely opportunities. DealCloud’s relationship intelligence manages and monitors your relationships with key connections, so you know which relationships are strong, which need building, and which are fading.
Learn — Get news on deals fast through DealCloud’s business intelligence and third-party data. DealCloud connects with leading investment and private equity suites to deliver information to you when it’s still actionable.

Get started now: Schedule a demo of DealCloud.