Fundraising for private credit funds involves positioning the strategy effectively within an asset class that has experienced significant growth and increasing competition. Institutional investors approach private credit allocations with specific objectives and concerns that differ from traditional private equity, requiring managers to tailor their fundraising approach accordingly. Success typically depends on clearly articulating the investment thesis, demonstrating relevant track record, and addressing operational capabilities that matter to credit investors.
Understanding the Investor Landscape
Private credit has attracted a diverse investor base with varying objectives and constraints. Understanding what different investor types seek helps managers focus their marketing efforts and tailor their messaging appropriately.
Insurance companies often represent significant allocators to private credit, attracted by the asset class's income characteristics and potential regulatory capital efficiency. These investors typically focus on yield, credit quality, and duration matching with their liability profiles. They may have specific requirements around investment-grade allocations or constraints on PIK exposure.
Pension funds approach private credit as part of their alternatives allocation, often seeking returns above public fixed income while accepting illiquidity. These investors tend to focus on total return potential and may be more comfortable with strategies that involve workout situations or credit deterioration if the manager can demonstrate expertise in these areas.
Family offices and endowments may prioritize different characteristics, with some seeking current income and others prioritizing capital appreciation potential. Understanding each prospect's specific objectives allows for more targeted conversations.
Positioning the Investment Strategy
Private credit encompasses a broad range of strategies with different risk-return profiles. Clearly positioning where the fund sits within this spectrum helps investors evaluate fit with their portfolios:
- Direct Lending: Senior secured loans to middle-market companies, typically offering lower yields but higher recovery expectations in distress.
- Unitranche: Single-tranche financing that blends senior and junior debt characteristics, offering higher yields with somewhat lower structural protection.
- Mezzanine: Subordinated debt often with equity participation, higher return targets, and commensurately higher risk.
- Distressed and Special Situations: Investments in stressed or distressed credits, requiring specialized restructuring capabilities.
- Asset-Based Lending: Loans secured by specific asset pools such as receivables, inventory, or equipment.
Investors appreciate clarity about where the strategy falls along the risk spectrum and how returns are expected to be generated. Overpromising yield or downplaying credit risk undermines credibility with sophisticated allocators.
Track Record Presentation
Private credit track records require thoughtful presentation because standard private equity metrics may not fully capture credit performance. Key elements to address include:
- Yield Performance: Historical gross and net yields, with breakdowns showing cash versus PIK components. Investors want to understand actual cash generation alongside total returns.
- Credit Quality: Historical loss rates, recovery rates on impaired positions, and comparison to relevant benchmarks. Transparency about credit problems demonstrates maturity.
- Portfolio Composition: Historical statistics on leverage levels, documentation quality, and structural protections obtained. This illustrates discipline in deal execution.
- Attribution Analysis: Breakdown of returns between spread income, fee income, and capital appreciation. This helps investors understand the sustainability of returns.
Due Diligence Considerations
Institutional investors conduct extensive due diligence before committing to private credit funds. Being prepared for this process accelerates fundraising and builds investor confidence:
- Operational Due Diligence: Credit investors often place significant weight on operational infrastructure, including loan documentation processes, covenant monitoring capabilities, and workout experience.
- Valuation Methodology: Detailed explanation of how positions are valued, including use of third parties, model inputs, and governance over valuation decisions.
- Risk Management: Portfolio construction approach, concentration limits, and processes for identifying and escalating credit deterioration.
- Reference Checks: Investors typically contact existing LPs, borrowers, and intermediaries to validate the manager's reputation and capabilities.
Fund Terms and Structure
Private credit fund terms have some differences from traditional private equity structures that warrant attention during fundraising:
- Fee Structures: Management fees may be calculated on invested capital, committed capital, or NAV, each with different implications. Performance fees may include hurdle rates and catch-up provisions.
- Distribution Policies: Investors in income-focused strategies often expect regular (typically quarterly) distributions. Clear policies on distribution timing and amounts should be established.
- Recycling Provisions: The ability to reinvest principal repayments affects deployment pace and fund duration. Terms should specify recycling rights clearly.
- Leverage Policies: If fund-level leverage will be used, terms should address leverage limits, disclosure requirements, and investor notification provisions.
Questions Investors Commonly Ask
- What is your historical loss rate, and how does it compare to industry benchmarks?
- How much of your historical return came from cash income versus PIK or capital appreciation?
- What is your workout experience, and can you provide case studies of problem credits you have managed?
- How do you source deals, and what percentage of your pipeline is proprietary versus intermediated?
- What is your team's experience through credit cycles, including periods of elevated defaults?
- How do you think about portfolio construction and concentration limits?