- What is private debt, how does it fit into the capital structure, and what actors are involved?
- Key strategies: direct lending, mezzanine, unitranche, special situations, distressed and venture debt.
- Advantages (diversification, variable coupon, flexibility) and risks (credit, illiquidity, legal) and how to mitigate them.
- Data from Spain: deleveraging, rising interest burden and debt service at manageable levels.
Private debt has gone from being a discreet corner of the financial system to making headlines in just a few years due to its growth and importance. According to recent international analyses, this market far exceeds $1.5 trillion in assets and is expected to continue expanding strongly, driven by corporate financing demands and investors' search for returns.
Beyond the numbers, what matters is understanding how it works, which types of companies it suits, and what it contributes to a well-diversified portfolio. In this practical guide, we bring together the key concepts, the most commonly used strategies, the risks and benefits, its role in capital structure, and recent data on the debt burden and service of the private sector in Spain from an international perspective.
What is private debt and how does it work?
In a broad sense, private debt is an alternative financing method used by unlisted companies , from startups to large corporations. Instead of issuing shares on public markets or raising capital, the company receives a loan from a specialized investor, usually through debt investment funds that pool capital from institutional investors and, in some cases, qualified individuals.
The mechanism is straightforward: the lender provides capital today and receives periodic interest payments as agreed; at maturity, the company repays the principal. These transactions are private, formalized with customized contracts, and generally have a fixed maturity date . The term "private" means precisely that the exchange occurs between non-public entities and that the borrowing company is not publicly traded.
A common advantage over a capital increase is that the company does not dilute its shareholders; in return, the lender negotiates protections (covenants), real or personal guarantees and specific conditions that seek to preserve its position in case of financial stress.
Capital structure and collection priority
To understand the risk and return of private debt, it's helpful to place it within the company's capital structure . At the top, the highest priority debt (senior debt) is the first to be repaid if something goes wrong; below it are subordinated tranches, and at the bottom are equity funds , which assume the greatest risk and are repaid last.
The loan's placement within this structure determines its profile: senior debt, with its guarantees and priority, is generally considered to have lower relative risk , while subordinated (junior) or hybrid (mezzanine) instruments offer higher coupons in exchange for being lower in the repayment order . This order of repayment is key in bankruptcies or restructurings.
Main strategies in private debt investment
Private debt funds specialize in various tactics depending on their objectives and risk profiles. Some strategies focus on preserving capital (more conservative), while others aim to generate appreciation through challenging market conditions. The most common strategies are described below.
Direct lending : bilateral financing for SMEs and medium-sized companies, with tailored contracts, protection through guarantees and covenants, and a typical term of 6 to 8 years (with possible extensions). It usually pays a variable coupon , which helps mitigate interest rate risk.
Mezzanine : a hybrid instrument between debt and equity that falls between senior and equity securities. It offers a higher return in exchange for greater structural risk and often incorporates warrants or options to participate in the company's appreciation .
Unitranche : combines senior and subordinated debt characteristics into a single tranche, simplifying the structure and accelerating closing. It provides flexibility for the borrower and often reduces the need to coordinate multiple lenders.
Special situations : opportunistic investments (e.g., discounted purchases in senior tranches) in contexts where there are temporary inefficiencies or urgent liquidity needs, with the aim of capturing value when the situation normalizes.
Distressed : loans or securities of companies in serious distress, where the investor assumes a high risk in exchange for potential returns if the restructuring is successful. This requires teams with legal and restructuring expertise.
Venture debt : financing for young companies with growth potential, often complementing equity rounds. It relies on business momentum and the expectation of scaling, but acknowledges the higher risk due to the early stage.
Trade finance : international trade finance solutions relevant for short-term transactions . In the hands of experienced teams and robust processes, it can offer an alternative source of profitability with a focus on liquidity and transaction risk control.
Advantages for companies and investors
For companies, private debt opens doors when bank loans are unavailable or their terms don't suit them. Its main appeal is flexibility : repayment terms tailored to cash flow, grace periods, customized structures, and covenants designed to align with the business plan 's key drivers.
For investors, its main value lies in diversification . Its performance shows low correlation with equities and, when properly constructed, it can stabilize a portfolio by providing coupons and collateral that support recovery in adverse scenarios.
In environments of high inflation and interest rates, variable-rate loans serve as additional protection , shifting some of the impact to coupons. This dynamic, along with credit selection, can improve the risk-adjusted return profile compared to other types of traditional debt.
Another key point is the support provided. Many managers not only lend money, but also offer advice and operational monitoring that reduces information asymmetries and facilitates plan execution, which can improve the borrower's chances of success .
Risks and how to mitigate them
Like any investment, it's not a smooth road. The first is credit risk : the possibility that the company will default on payments. This is managed with rigorous analysis, adequate guarantees, and structures that include actionable covenants should warning signs appear.
Illiquidity is the second major factor. Without a secondary market as developed as that for government bonds, unwinding positions can be costly or slow. In return, investors expect an illiquidity premium to compensate for the reduced ability to exit early.
It's also important to consider economic or credit cycle risks (if growth slows, delinquency increases), operational risks (internal processes, custody, valuations ), and legal or jurisdictional risks (enforcement of guarantees, court delays). Therefore, the choice of manager is crucial.
The complexity of the contracts and the costs (higher interest rates and fees) reflect the greater risk involved. For non-professional investors, the reasonable recommendation is to use managers with a proven track record and robust controls, who demonstrate consistency and transparency in credit committees, reporting, and governance.
Key data: debt, debt burden and debt service in Spain
The financial health of the private sector is measured, among other things, by its ability to pay interest and principal each year. In Spain, following the credit boom prior to 2008, companies and households have undergone significant deleveraging, which has improved the sustainability of their balance sheets.
In 2008, consolidated private debt reached nearly 200% of GDP . Since then, the ratio has fallen sharply. For companies, debt decreased from approximately 115% of GDP in 2008 to around 65% in 2023; for households, from 82,6% to around 47%. This trend places Spain, according to the latest comparable data, below the EU-27 average .
Sustainability is also evident when considering how many years of income or profit would be needed to pay off the debt. For companies, the number of years has decreased from just over five to slightly over three ; for households, from 1,32 to around 0,74 years . Compared to Europe, this trend has allowed Spain to show more favorable ratios today than a decade and a half ago.
With the ECB's interest rate hikes that began in mid-2022, the interest burden increased in 2023: for businesses, the share of interest in their gross surplus rose from 7% to 13% in one year; for households, from 1,8% to 2,6% . The total amount of interest paid by the private sector increased significantly compared to the previous year.
If we include amortization and associated costs, debt servicing provides a complete picture of the annual effort. In 2023, Spanish companies allocated around 34,7% of their income to debt servicing, and households around 5,6% . Despite rising interest rates, the ratio did not worsen compared to 2022 thanks to lower indebtedness and rising incomes, placing Spain in a relatively comfortable position within broader international comparisons.
Who manages and how does a specialized team operate?
Success in private debt relies on teams with cross-disciplinary experience. The most valued assets are combined backgrounds in leveraged banking , corporate finance, accounting, consulting, and industry, and close relationships with sponsors, lenders, and advisors across multiple European jurisdictions.
Teams with a local presence in several European capitals , agile investment processes, and direct involvement of senior partners often have a competitive advantage in time-sensitive processes. Some asset managers have invested over €2.6 billion in more than 100 companies in the last decade, demonstrating scalability and the ability to execute across different cycles.
Use cases: growth, acquisitions, and refinancings
Private debt can be used to finance organic growth (new product lines, geographic expansion) or inorganic growth (acquisitions), as well as to refinance existing liabilities. It often complements venture capital : following the investment of a private equity fund, a tranche of ad hoc direct loans can complete the investment plan.
In Spain, specific debt vehicles for SMEs have emerged, domiciled locally, with fundraising targets in the tens of millions of euros and a focus on providing flexible, long-term financing to strong management teams. These types of funds reflect the maturity of the market and its attention to the business sector.
FAQ
Is it suitable for any company? It can fit a wide variety of profiles, especially those that require flexible terms and conditions , or that do not have access (or do not wish to use) traditional bank financing at that time.
How do interest rates compare to a bank loan? They tend to be higher , in line with the greater risk and the personalized nature of the loan. In return, the structure and covenants are tailored to the business and projected cash flow.
Is it faster to close a deal than with a bank? Often, yes. Bilateral negotiations and centralized decision-making allow for faster analysis and disbursement times, crucial when opportunities are limited.
What maturity and coupon are typical? In direct lending, it is most common to see maturities between 6 and 8 years (with possible extensions), and variable coupons linked to market benchmarks to mitigate interest rate risk.
Best practices when selecting a private debt fund
It requires a methodical process. Review the manager's track record , their performance in different cycles, the default and recovery rates, the depth of the risk team , and their governance. Ask about collateral documentation, the most commonly used covenants, and pricing discipline.
Check the fit in your portfolio: what role it will play ( coupon stabilizer , return enhancer, diversifier against equities), its expected correlation with other positions, and sector and geographical exposure to avoid concentrations.
Legal framework, investor profile and notices
Much of the information and documentation regarding private debt is directed to institutional or qualified investors . This information does not constitute an offer to sell or solicit to buy securities, nor an invitation to subscribe to management mandates . Its purpose is informational and may be subject to access restrictions.
Past performance is not indicative of future results, and there is always a possibility of capital loss. Access to informational platforms or pages may be withdrawn without prior notice, and their availability is not guaranteed at all times. Anyone who does not accept these conditions should refrain from continuing.
How to fit private debt into asset allocation
For portfolios with a bias towards equities and government bonds, incorporating private debt typically improves the risk-return profile due to its low correlation and coupon flow. It is particularly useful for slightly increasing expected returns without assuming excessive additional volatility .
A sensible way to start is with preservation strategies (senior direct lending) and, over time, gradually increase exposure to more complex opportunities (special situations, distressed ) according to risk appetite, available liquidity and the team's experience.
In high-interest-rate environments, variable-rate bonds act as a buffer against inflation and rising interest rates. And, if structured with appropriate guarantees and covenants, the lender has protective mechanisms and the ability to intervene early.
When credit becomes more expensive or scarce, private debt can replace (or complement) bank financing and accelerate critical growth or consolidation decisions, maintaining the agility required by faster market cycles.
All of the above demonstrates that private debt is not a homogeneous block, but rather an ecosystem of solutions that adapts to the economic cycle, the sector, and the size of the company. When properly analyzed and managed by competent professionals, it can diversify portfolios, offer competitive coupons, act as partial protection against interest rates and inflation, and simultaneously provide flexible capital for companies to execute their plans. The key lies in understanding the capital structure, assessing the risks (credit, liquidity, operational, and legal), and relying on teams with proven experience that demonstrate discipline, speed of execution, and strong recovery rates when the going gets tough.
