Private Credit Preparation

These pages are dedicated towards modeling / case study prep. I want to limit repetitive information you can find elsewhere online. For detail about what is PC, different types of PC strategies, and what the associate role looks like ---scroll to the bottom.

6 Private Equity LBO Models Available for Premium Subscribers under the 'Models & Case Studies' filter!

Modeling / Case Studies:

Traditional private credit is lending 1st lien term loans to sponsor-backed businesses. So, the crux of the job is still LBOs, but you're working on the lending side vs. the ownership side. Please reference what I wrote about here: Private Equity Recruiting | Buyside Associate Recruiting to understand how the LBO process works / excel steps you need to take. 

What I detail below are some of the nuances that you need to consider for private credit modeling / case studies that are different from what you see with PE prep. 

PC Returns Analysis (Net Gain, MOIC, and IRR): 

  1. Your 'purchase' is the (principal balance of your lend * OID) - financing fees
  2. Cash flows are: cash interest + principal payments + prepayments
  3. Your 'exit' is the repayment of your outstanding principal balance
  4. Some important considerations: OID is a mechanism to enhance the return of your lend, PIK interest accrues to the debt balance and is not a cash flow, lenders typically target ~15% IRRs

Key Credit Ratios: 

  • Leverage Ratio (Debt / EBITDA): Typically 4-6.0x for an LBO. Want to see this de-lever over the life of the investment
  • Interest Coverage Ratio (EBIT/ Interest Expense): 1.5x is typically the minimum threshold and 3.0x is very good. Want to see how many multiples of EBIT a business has relative to its interest to gauge its ability to service debt
  • Fixed Charge Coverage Ratio ((EBIT + Fixed Charges) / (Fixed Charges + Interest)): 1.0x is the absolute bare minimum with 2.0x standing as solid coverage. Want to see how well a business can cover all fixed costs in the event it encounters a business cycle

A Little Bit About PC:

This is going to be brief, I do not want to waste time on areas you can just Google. 

The nature of private credit is lending to businesses and holding these loans until maturity. Unlike public credit, these loans are typically not sold to other investors. PC loans are bilateral transactions between the lender and the business; also broadly known as 'direct lending.' There are many firms that engage in direct lending including: banks, fintechs, loan sharks, private credit firms, etc. What separates private credit from other direct lenders is that private credit involves lending capital out of a fund structure. 

Similar to PE, a PC fund raises capital from Limited Partners (LPs) such as insurance companies, endowments, and pension funds to originate loans within a 5-7 year horizon. PC funds usually deploy a 1.5/15 model (1.5% management fee on all AUM, 15% on excess returns from investments). PC funds generate a return on their loans by lending at a spread of SOFR (usually 450 - 800bps for your average term loan).  

Everyone tries to make a 13-20% IRR on their investments. 

"If you can make 12-13% on bank loans, what else do you really want to do in life?" -Steve Schwarzman

Different Types of PC:

Also, will not spend a ton of time here because you can find this detail on Google.

Just like private equity, private credit is broadly split across Mega-Fund ($100bn+ AUM), Upper-Middle Market ($500mm - $1bn AUM), Middle Market ($250mm - $500mm AUM), and Lower-Middle Market funds (less than $250mm AUM). 

Different Credit Strategies (some are more public credit in nature):

  1. Traditional PC (originating term loans for sponsor-backed LBOs)--most PC roles are traditional 
  2. Non-Sponsor Backed Lending (originating term loans for non-sponsor backed businesses)
  3. Junior Capital (greater focus on investing in junior debt across transactions. Senior notes, convertible debt, 2nd lien term loans, etc)
  4. Opportunistic Credit (investing across the debt cap stack to achieve an optimal risk / return; typically dealing with riskier businesses)
  5. Distressed Debt (investing in the debt of failing businesses, typically buying debt at tremendous discounts; sometimes working out a loan-to-own strategy)
  6. Fund Lending (lending to other funds: NAV loans, subscription lines, and back-leverage warehouses)
  7. Infrastructure / Real Estate (originating loans for infrastructure / real estate projects)
  8. Asset-Backed Finance (lending against a specific pool of assets in bankruptcy-remote structures) 
  9. Venture Debt (lending to venture-backed businesses / startups)

The Associate Role:

Traditional PC is incredibly similar to working on a leveraged finance desk. You're originating loans to support the capital structures of different transactions---specifically LBOs. Once again, most PC associate roles are incredibly similar to your experience as a banking analyst. However, unlike PE and depending on your shop, the hours tend to be a little more chill and you're not focused on operationally enhancing a business. Your job is really to help sponsors juice their investments in cash flowing businesses. 

Unlike PE, you see a ton of transaction volume in PC. The classic saying is that in PC, you go a mile wide and a foot deep on deals vs. a foot wide and a mile deep in PE. This is important because the beauty of PC is that you can stack deals one after another to deploy capital and generate returns without incredibly intensive maintenance of the underlying deals. After all, you do not hold the equity and do not have the vote to dick around with a business's operations. 

Your core responsibilities include:

You're doing the grunt work. However, just like PE, these are investments that your bosses may have substantial money invested via carry. So, they care about every little detail and rely on you to do things right without being told twice / needing hand-holding.

Seniors do most of the sourcing and legal doc negotiation. Associates do most of the slide creation and modeling.  

Again, the reason to go into PC is because you want to take meaningful risk. It's definitely more of a financing role than a pureplay investing role; however, unlike banking there is no advisory work. Your analysis is strictly focused on making money-good loans. Politically, you're working with demanding sponsors to negotiate favorable outcomes for all parties involved.