Private Debt | Meaning, Process and Types

What is Private Debt?

Private Debts can be defined as loans provided by private financial institutions like banks, private equity firms, hedge funds, etc. Companies need funds to operate their operations, and they sometimes prefer private sources of funding i.e., Private Debts. This type of debt provides customisable and flexible plans of debt according to the needs of the borrower. The loans are generally borrowed by businesses, individuals, or non-government entities but not borrowed from public or government institutions. Borrowing private debt from private organisations provides flexibility and customisable financing. There are various stages in the process of obtaining public debts, such as preparation of the plan, selection of lenders, negotiation, due diligence, closing, and at last, the repayment. The repayment of private debt is done at a fixed schedule date and may have a fixed or even variable rate of interest.

Process of Obtaining Private Debt

The process of obtaining private debts can be different according to the needs of the borrowers and the conditions of lenders. There is a prespecified process of obtaining private debts from a particular source that the potential borrower needs to follow. In general, the process may include the following steps:

1. Preparation of Plan: The initial stage of obtaining a private debt is the preparation of the plan. In this step, the borrowers of private debt need to prepare a business plan and financial projections and gather financial statements and other required documents. This plan and projection then describe the ability to repay the private debt to the lender.

2. Selection of Lenders: The borrower then selects a lender who is ready to provide the private debt within a given period and at a specified rate of interest. The lenders can be private firms, banks, or financial institutions.

3. Negotiation: The borrower then negotiates with the lender regarding the details of the rate of interest. period for repayment, other conditions, and facilities being provided by the lender. According to the type of lender, all the required factors do vary.

4. Due Diligence: To confirm the debt the lenders conduct a due diligence review regarding the business operations and financials of the borrower. This due diligence helps lenders to know the ability of borrowers to repay the private debt.

5. Closing: When lenders are satisfied with the due diligence process and regarding the ability to repay debt, they close the debt and provide the required amount of debt to the borrowers.

6. Repayment: According to the agreement signed between the lender and the borrower, the borrower needs to make regular payments of debt to the lender.

Types of Private Debt

Individuals or companies borrowing for public debt can use several financing techniques. These techniques can differ in characteristics and advantages. The most common types of personal debts are given below:

1. Corporate Bonds

Corporate bonds can be defined as a type of private debt securities that are borrowed by corporations to raise their capital from the public markets. Corporate bonds differ in terms of risk and yield. The lending party provides money to corporations for a specific period with prespecified interest payments. For example, boAt issues some corporate bonds to raise funds to expand its product line. Such types of bonds are traded on the open market and they pay a fixed rate of interest.

2. Mezzanine Financing

Mezzanine financing can be defined as a type of private debt that is used by companies and organizations that are preparing for an Initial Public Offering(IPO). Mezzanine financing consists of features such as convertible notes. Such type of debt is considered more risky than senior debt. Such types of public debts are more costlier than traditional methods of bank loans. For example, A software company uses mezzanine financing from a private financial institution for faster growth and development. Such debts are a combination of equity debts and subordinated debts.

3. Senior Secured Debt

Many times, the individual or business organization borrowing private debt thinks of the security of their assets. Senior secured debt thus provides the security of the assets which states that the lender of debt has claimed on their specific investments. Senior secured debts are mainly less risky for investors. The interest rate for senior secured debts is also less as compared to other types of private debts. For example, A sugarcane insert issues senior secured debt from a financial institution of the country. They want to make use of this debt for the construction of a new plant. Therefore the lender claims for the assets of powerplant by default.

4. Junior Debt

Junior debt is a type of private debt that is considered less priority than senior secured debt. The parties holding debt need to pay the amount after senior secured debt in case of bankruptcy, financial distress, or any financial war-like conditions. The investors offer high interest rates in case of junior debt because they are highly prone to risks. For example, A retail company issues junior debt for their company in the form of subordinated bonds for their market expansion. Further, in any case of financial difficulties, these bonds will be paid after the senior debt holders.

5. Uni-Tranche Debt

Uni-tranche debt is a combination of senior secured debt and mezzanine financing debt. Uni-tranche debts are types of debts that are provided by a single user only. Uni-tranche debts are less risky as compared to mezzanine financing debts and are more secure in terms of assets. As Uni-tranche debts are hybrid they are more expensive as compared to senior secured debts. For example, a hotel group secures their Uni tranche debt from financial institutions or from private equity firms to renovate their place. This debt will be then backed by the assets of the hotel and a combination of senior secured debts and mezzanine financing.

6. Asset-Based Lending

Asset-based lending is a type of private debt that is secured through the assets of the borrower. This asset can consist of inventory, equipment, tangible assets, etc. Lenders make use of the assets of the borrower so that it would be a less risky process. Asset-based lending is majorly used by most companies and organizations to finance their working capital needs or to finance their specific projects. For example, A transportation company makes use of asset-based lending for financing their vehicles. In such type of debt, the lenders will then provide a revolving credit line that is based on the inventory and receiving account value of the company.

7. Real Estate Financing

Real estate financing is defined as a type of private debt that is used for purchasing or developing any residential or commercial properties. Real estate financing has multiple forms such as commercial estate loans, construction loans, mortgages, etc. In real estate financing the terms of financing differ from one other. It is majorly based on the type of real estate. For example, a property firm takes real estate financing for purchasing their office building. This type of debt can consist of a commercial real estate loan in which the property will serve as collateral.

8. Leveraged Loans

Leveraged loans are defined as a type of private debt that is extended to organizations, companies, or individuals along with a very high amount of debt. Leveraged loans are majorly used to finance mergers, acquisitions, and other types of investments. Leveraged loans generally have high risks therefore to attract lenders borrowers offer high rates of interest. For example, A retail company can take leveraged loans to support its expansion in multiple regions of the country. This loan will be then secured by the assets of the company.