Private credit and private equity are two distinct forms of alternative investing. Private credit involves direct lending to businesses, often by wealthy individuals or firms, while private equity means buying a stake in a company to become a part owner. This guide breaks down the key differences between the two and how each strategy can fit into your broader investment portfolio.
Money.ca takeaways
- Private credit and private equity are both alternative investments, offering access to private markets outside traditional banking and stock exchanges.
- Private credit involves lending money to businesses in exchange for interest payments, often with flexible, negotiated terms.
- Private equity means buying ownership stakes in private companies, with potential for long-term capital gains if the business grows or is sold.
- Both options are typically illiquid and high-risk, but can offer high returns for experienced or accredited investors.
Private credit investing explained
Private credit is a term for loans made to a business outside bank loans and traditional debt financing, such as corporate bonds. Private credit investors are sometimes willing to make riskier loans to startups and struggling businesses for a higher interest rate. In comparison, banks and traditional business financing vehicles may not be open to these riskier loans.
Key context
Types of private credit
- Direct lending: Loans made directly to mid-sized companies
- Mezzanine financing: Hybrid of debt and equity with high yield
- Distressed debt: Buying debt from struggling or bankrupt companies
- Special situations lending: Financing tied to unique, high-risk events
- Asset-based lending: Loans secured by company assets like inventory or equipment
The lender and the borrower can negotiate unique terms that suit their needs and goals. That can include long payoff periods, a delay before the first payment is due, an option to convert debt to equity, or anything else they find to be a win-win scenario.
Private credit investing pros and cons
Here’s a look at several of the most important pros and cons of private credit for investors:
- High yield for investors
- Enables businesses to access non-traditional lending sources
- Flexible lending terms
- Predictable cash flow
- Higher risk of losses
- Low liquidity
- More challenging due diligence
- Potential complexity
Private equity explained
Private equity is a term for private investments in a business in exchange for partial ownership. Instead of raising capital by issuing shares of stock in the public stock markets, private equity enables companies and investors to reach mutually agreed-upon terms, including negotiating an off-market valuation of the business.
Private equity in Canada allows businesses to raise capital without going public on exchanges like the TSX, or meeting disclosure rules under provincial securities acts.
For companies receiving private equity investments, managers can access additional funds without the regulatory requirements of Canadian securities commissions, like the Ontario Securities Commission (OSC) or other provincial regulators.
Private equity investing pros and cons
- High potential returns
- More influence over the business
- Access to unique investment opportunities
- Diversification into less traditional investments
- Higher risk of losses
- Low liquidity
- May have to wait many years for a payoff
- Large minimum investment
Private credit vs. private equity: How they’re different
- Type of investment: Private credit involves lending money to private companies and earning returns through interest payments. Private equity involves purchasing equity stakes in private companies, aiming to profit from their growth and eventual sale.
- Risk and return profile: Private credit typically offers more stable and predictable returns through interest payments but with lower upside potential. Private equity carries higher risk due to its reliance on company performance but offers potentially higher returns from equity appreciation.
- Active vs. passive management: Private credit investors usually play a more passive role, primarily focusing on borrowers' creditworthiness and loan terms. However, private equity investors often take an active role in managing and improving the operations of portfolio companies.
- Income generation vs. capital appreciation: Private credit focuses on generating regular income through interest payments, making it attractive for income-seeking investors. Private equity focuses on capital appreciation through the growth and eventual sale of the company, making it suitable for investors seeking long-term capital gains.
Private credit vs. private equity: How they’re similar
- High potential returns: Both types of investments aim to deliver higher returns than traditional fixed-income or equity investments, compensating for their higher risk and lower liquidity.
- Access to private markets: Investors in private credit and private equity gain exposure to private companies, which are not available through public markets.
- Liquidity: Private credit investments are generally more liquid than private equity investments, although both are less liquid than public market investments. Private equity investments often have long lock-up periods before investors can realize returns.
- Exclusive access: It's worth noting that due to the high minimum investment requirements and the complexity of the investments, both private credit and private equity are typically accessible to a select group of investors, namely institutional investors and accredited individuals. In Canada, you typically need to qualify as an accredited investor, meaning you earn at least $200,000 individually or $300,000 with a spouse over the last two years, or have $1 million in financial assets (excluding real estate)
Tax implications: Interest income vs. capital gains
When investing in private credit or private equity, you need to factor in how Canada taxes different types of returns. Interest income from private credit is taxed at your full marginal rate — the same as regular employment income — which can significantly reduce your after-tax returns.
On the other hand, private equity investments typically generate capital gains, which are more tax-efficient since only 50% of the gain is taxable. If you’re investing through a corporation, trust, or registered account, the tax treatment may vary — and in most cases, you can’t hold these types of alternative investments in registered accounts like your RRSP or TFSA.
- Key considerations
- Private credit: Interest income is fully taxable at your marginal tax rate.
- Private equity: Capital gains are 50% taxable, offering a more favourable tax treatment.
- Registered accounts: Most private investments can’t be held in RRSPs, TFSAs, or RESPs.
- Professional advice: Work with a tax advisor or accountant if you're unsure how to structure these investments.
Is private equity investing right for me?
Private equity is often reserved for high-net-worth individuals and highly focused private equity investment firms. However, like private credit, other educated and experienced investors may be able to gain access to private equity deals. Like private credit, you should only proceed if you completely understand the risks and potential payoff of the company you’re considering for an investment.
Also, like private credit, investing only in what you can afford to lose is best. While you’ll hopefully earn 10x or more from private equity investments, there’s always a chance the company will go out of business, and you won’t see any return.
How to begin investing in private equity
Direct private equity deals are often only offered to investors with high net worths reaching the millions. However, if you have a six-figure net worth, you may still find platforms allowing you to pool your money with others in a private equity fund. You’ll generally need to be an accredited investor criteria to participate.
If you’re an accredited investor, you can begin investing in private equity by searching for suitable funds and alternative investment platforms for your long-term financial goals.
- Private credit access: Offered through a managed fund structure — not individual loans.
- Eligibility: You must be an accredited investor under Canadian securities law.
- Minimum Investment: Typically starts at $10,000+ and is subject to availability.
- Liquidity: Limited — these are longer-term investments with restrictions on withdrawals.
- Tax note: Any interest earned is taxed as regular income, not capital gains.
Wealthsimple recently launched Wealthsimple Private Credit, a fund targeting accredited investors, giving you exposure to private debt with the goal of generating higher yields than traditional bonds.
So while you can’t build a custom private credit portfolio through Wealthsimple, their offering makes it easier for qualified investors to get exposure without needing to source deals themselves.
FAQ
Eric Rosenberg is a finance, travel and technology writer in Ventura, California. He is a former bank manager and corporate finance and accounting professional who left his day job in 2016 to take his online side hustle full time. He has in-depth experience writing about banking, credit cards, investing and other financial topics and is an avid travel hacker. When away from the keyboard, Eric enjoys exploring the world, flying small airplanes, discovering new craft beers and spending time with his wife and little girls.
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