What Is Private Credit? How It Works, What It Funds, and What It Costs

The gap private credit fills

Most companies that make things need credit before they see profit. A manufacturer lands a large order, and the steel has to be bought and the crew paid months before the customer pays. For a long time a bank usually sat in that gap. More and more often, a private credit fund does [3].

We care about private credit because of what it pays for. Sebastian J. Harris, Sandbox's founding partner, describes capital in Foundations as stored productive capacity: the means by which today's resources become tomorrow's factories, shipments, and payrolls. Credit is the least glamorous form of that, and one of the most consequential. It is also not a savings account with a better rate, and the rest of this piece covers where its structure helps and where it costs. (Sandbox's funds are available only to qualified purchasers who are accredited investors; this article is education, not an offer.)

How private credit differs from bank loans and public credit

Federal Reserve staff describe private credit as "debt-like, non-publicly traded instruments provided by non-bank entities, such as private credit funds or business development companies (BDCs), to fund private businesses" [1]. Two comparisons make that concrete.

Against a bank loan, the difference is whose money it is. A bank lends against deposits and answers to bank regulators. A private credit fund lends money its investors committed, and it can set terms around one borrower's needs "without the need to comply with traditional regulatory requirements" [1].

Against public credit, the difference is how the loan is sold and priced. A broadly syndicated leveraged loan is arranged by large banks, spread across many institutional investors, traded afterward, and priced by the market every day. A private credit loan stays with one lender or a small group. It has no secondary market, and its value is set by internal or third-party models, usually each quarter [2].

Both differences cut two ways. Negotiating directly gets a borrower terms a syndicated process can't offer. But the value a private lender reports is its own estimate, not a price anyone actually paid. You gain flexibility. You give up an outside check on what the loan is worth.

The main kinds of private lending

Federal Reserve staff name direct lending, the largest, plus mezzanine, special situations, distressed, venture, and infrastructure debt [1]; BIS research adds asset-based lending [3].

• Direct lending: loans made straight to operating companies, generally senior secured [1].
• Asset-backed and specialty finance: loans against specific assets or receivables, not only against a company's overall cash flow.
• Mezzanine: debt that sits between senior loans and equity. If the borrower struggles, it takes losses before senior lenders do.
• Distressed and special situations: lending to companies under strain, where the outcome depends on a restructuring more than on scheduled payments.
• Venture debt: loans to venture-backed companies that are often not yet profitable, where repayment can hinge on the next funding round.

These carry very different risks. Direct lending loans "are typically senior secured while other private credit strategies can invest in more junior parts of the capital structure" [1]. The same struggling borrower can leave one lender whole and another with a loss.

Why borrowers pay for it, and what they give up

Borrowers "have been willing to pay a premium for the speed and certainty of execution, agility, and customization that private lenders offer" [1]. Discretion comes with the structure too: these borrowers usually have no public credit rating and no syndication process to disclose into [2].

There is another side. Private lenders have also drawn "highly leveraged borrowers that are unable to get adequate funding from heavily regulated banks" [1]. On 2025 issuance, the median private credit borrower had about $223 million in revenue against about $902 million for leveraged-loan borrowers, and debt of about 5.0 times EBITDA against about 3.2 times [2]. The customization is real. So is a borrower base with fewer places to go.

Who lends, and who invests

The lenders are private debt funds and BDCs. A BDC is a closed-end investment company created by the Small Business Investment Incentive Act of 1980 to channel capital to small and mid-sized private businesses [1]. Interval funds and other retail-oriented vehicles take part as well [2].

Behind those vehicles sit pension funds, insurance companies, family offices, sovereign wealth funds, and wealthy individuals [1].

The funds borrow too. Committed credit lines from the largest U.S. banks to private credit vehicles grew from about $8 billion in the first quarter of 2013 to about $95 billion by the fourth quarter of 2024 [4], and fund-level borrowing makes loan outcomes larger in both directions. Federal Reserve staff add that "the lack of transparency and understanding of the interconnectedness between private credit and the rest of the financial system makes it difficult to assess the implications for systemic vulnerabilities" [4].

Who can invest depends on the vehicle. Private funds are generally limited to accredited investors, a standard meant for people "financially sophisticated and able to fend for themselves or sustain the risk of loss" [6], and many add the higher qualified purchaser test. See qualified purchaser and how to invest in private credit.

How lenders earn, and what erodes it

A private credit lender earns from a loan contract, not from owning a piece of the company (private credit vs private equity). Four parts of that contract explain where the income starts and what can stop it.

Interest. The borrower owes interest under a negotiated credit agreement. The payments are scheduled, and they arrive only as long as the borrower can make them.

Floating rates. "Almost all private credit loans are floating rate" [1], so the rate resets with a benchmark. When rates rise, the lender's income and the borrower's cost rise together, and Federal Reserve staff warn that higher payments "could stress borrowers' balance sheets, leading to a significant increase in defaults in an economic downturn" [1]. The same mechanism that lifts income raises the chance of default.

Fees and terms. Because the loans are held rather than traded, contracts can include things rare in bank lending: "a structured equity component, high prepayment penalties, or a role in oversight or management of the company" [1]. Every one of them still depends on the borrower doing well.

Seniority and collateral. Direct lending loans are generally senior secured [1]. That decides who gets repaid first and from what if a borrower fails. It doesn't decide whether a loss happens.

What wears income down is the mirror image: defaults, recoveries below what was lent, fund expenses and borrowing costs, and looser underwriting when money is plentiful. A large pile of committed but uninvested capital "could compromise underwriting standards" as managers compete for deals [1]. None of this says how much any loan earns; it shows where income comes from and what takes it away.

How large the private credit market is

Private credit and the broadly syndicated leveraged loan market are "roughly equal in size — approximately $1.4 trillion as of the end of 2025." Together they make up around 20 percent of all lending to nonfinancial corporations as of the first quarter of 2026, and around 45 percent of lending to private nonfinancial corporations [2].

Most of the growth is recent and American. Global private credit loans outstanding rose from around $100 billion in 2010 to over $1.2 trillion, with more than 87 percent originated in the United States [3].

What investors give up: illiquidity, estimated values, and wide gaps between managers

"Private credit loans are illiquid due to the lack of a secondary market. There is limited market discovery, and investors acquiring these loans should expect to hold them to maturity or face steep losses in need of an emergency exit" [1]. Fund lock-ups can run as long as ten years [1]. Shares in non-traded BDCs can't be readily sold either. Retail-offered BDCs generally buy back shares only monthly or quarterly, and an investor in a private BDC may have no exit until it lists, sells its portfolio, or winds down [5].

Illiquidity isn't only a cost. It is what lets a lender underwrite a loan to hold, structure it around one company, and avoid being forced to sell in a downturn. But the investor carries that constraint, not the loan.

The same structure produces big differences between managers. Terms are negotiated loan by loan. No market settles what a loan is worth. Values come from models each quarter rather than daily prices [2]. And individual funds tend to be concentrated by industry, with a Herfindahl-Hirschman Index averaging 0.74 to 0.81 against 0.2 to 0.4 for bank syndicated lending [3]. Focus can reflect real expertise in a sector, but "a lack of diversification could expose funds to sector-specific downturns" [3], and the market has not yet been through a full credit cycle at its current size [3]. Two managers describing the same strategy can be running very different books.

What credit leaves behind

We start with what a business needs to get built, then ask what kind of capital fits. A company with a decade of research ahead needs patient equity. A company with orders to fill usually needs working capital, and that is credit's job. As Seb writes in Foundations: "The investment vehicle is a consequence of the thesis, never the thesis itself."

A loan is a different relationship from an ownership stake. The lender is repaid on a schedule, and the founder generally keeps ownership. But the lender also holds rights under the credit agreement, and if the business stumbles, those rights can come due at the worst moment for the company.

That is why we take the costs above seriously. When a loan has no market price, someone has to judge what it is worth. When two managers running "the same strategy" hold very different books, the difference comes down to judgment: whom they lend to, on what terms, and what they turn down.

What matters in the end is what the capital leaves behind: an order filled, a payroll met, a company still standing after the loan is repaid.

Frequently asked questions

Is private credit the same as direct lending?

No. Direct lending is the largest part of private credit, not another name for it: about $800 billion of nearly $1.7 trillion in assets under management as of June 2023 [1]. Mezzanine, distressed, venture debt, and asset-based lending make up the rest, at different places in the capital structure [1][3].

Is a private credit loan secured?

Often, but not always. Direct lending loans are typically senior secured, while other strategies lend further down the capital structure [1]. Security gives the lender a claim on collateral and a place in line for repayment. It doesn't ensure full repayment, and collateral can lose value.

How are private credit investments valued?

By model, not by market. Positions are valued with internal or third-party models each quarter, while leveraged loans are priced by the market daily [2]. With no secondary market to test a valuation against [1][2], how a manager values its loans, and who checks it, is a core diligence question.

Who is eligible to invest in private credit funds?

It depends on the vehicle. Publicly traded BDCs are open to retail investors. Private funds are generally limited to accredited investors, and often to qualified purchasers as well [6]. See qualified purchaser.

Why has private credit grown so quickly?

BIS research finds private credit is larger in countries with lower policy rates, less efficient banking sectors, and, to some extent, stricter bank regulation, and that the funding-cost advantage banks held over BDCs narrowed substantially between the Great Financial Crisis and 2019 [3]. Federal Reserve staff point to regulatory and supervisory changes, the growth of private equity, and borrowers' demand for speed and customization [1].

Sources

1. [1] Board of Governors of the Federal Reserve System — Private Credit: Characteristics and Risks (FEDS Notes, February 23, 2024). https://www.federalreserve.gov/econres/notes/feds-notes/private-credit-characteristics-and-risks-20240223.html. Accessed 2026-08-12.
2. [2] Board of Governors of the Federal Reserve System — Private Credit and Leveraged Loan Markets: Similarities, Differences, and Substitution (FEDS Notes, August 11, 2026). https://www.federalreserve.gov/econres/notes/feds-notes/private-credit-and-leveraged-loan-markets-similarities-differences-and-substitution-20260811.html. Accessed 2026-08-12.
3. [3] Bank for International Settlements — The global drivers of private credit (BIS Quarterly Review, March 11, 2025). https://www.bis.org/publ/qtrpdf/r_qt2503b.htm. Accessed 2026-08-12.
4. [4] Board of Governors of the Federal Reserve System — Bank Lending to Private Credit: Size, Characteristics, and Financial Stability Implications (FEDS Notes, May 23, 2025). https://www.federalreserve.gov/econres/notes/feds-notes/bank-lending-to-private-credit-size-characteristics-and-financial-stability-implications-20250523.html. Accessed 2026-08-12.
5. [5] U.S. Securities and Exchange Commission, Office of Investor Education and Advocacy — Investor Bulletin: Non-Publicly Traded Business Development Companies (BDCs), December 13, 2024. https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-bulletins/investor-bulletin-non-publicly-traded-business-development-companies-bdcs. Accessed 2026-08-12.
6. [6] U.S. Securities and Exchange Commission, Office of Investor Education and Advocacy — Accredited Investors, Updated Investor Bulletin, April 14, 2021. https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-bulletins/updated-3. Accessed 2026-08-12.