Private credit: The rise of a diverse capital solution

Private credit has the potential to serve a larger market need, supplant traditional and alternative pools of capital

Private credit as a rapidly growing asset class in India is poised to bring transformative change. Its growth is driven by a thriving entrepreneurial ecosystem, a large universe of high-quality businesses, increasing investor awareness and confidence in this asset class, and consistent tax treatment across debt products. For desirable and sustainable investment outcomes over multiple fund cycles, investment managers in this space may need to evolve and adapt to changing market dynamics and emerging opportunities. As it matures, it can transition from being solely a financial product to becoming a versatile capital solution that caters to the capital needs of established businesses.
 

Triggered by the global meltdown of 2008-09 and later events like the IL&FS blowout and the pandemic, the credit market had become focused on traditional products: Bank debt or non-convertible debentures available mainly for higher-rated companies (AA- and above). With fewer wholesale non-banking financial companies focusing on this space, private credit funds have come to the forefront as an important financing option.
 

Currently estimated to be at $4 billion in transaction value in the first half of calendar year 2023, compared to $5.3 billion in CY22, this market is experiencing strong demand from companies for bespoke financing solutions. There’s an increasing appetite for this asset class among domestic high-net-worth individuals aided by recent tax changes for market-linked debentures and debt mutual funds which has created a level playing field for all debt products.
 

Companies will have diverse types of capital requirements. These funds offer debt or debt-like instruments to companies (or promoters) to fulfil specific needs in appropriate structures for a particular situation that may not be met by traditional debt providers – due to specific lending norms, regulations or differing outlooks on industry/business, and risk appetite. These needs include promoter financing, acquisition financing, capital structure optimisation, special situation funding, bridge to initial public offerings, growth and distressed funding, and many more. Most of these custom financings are directed towards private companies with yields ranging between 12 per cent and 18 per cent for performing credit; 18 per cent and 20 per cent for special situations; and 20 per cent plus for distressed funding.
 

Private credit financing commonly involves fixed contractual returns, and in certain instances the structures are designed to present upside potential while mitigating downside risks through safeguards such as majority ownership of the operating business, charge on assets, promoter guarantees, etc.
 

As market cycles change, investment structures may have to evolve to enable investment managers to be agile in seizing opportunities. Instead of solely relying on a single product strategy, investment managers may find it advantageous to explore the utilisation of multiple financial instruments to enhance their investment strategies. By incorporating products such as convertibles, hybrid structures, and other innovative solutions that combine the unique characteristics of different instruments, investment managers can provide added flexibility and potential for equity-like returns while also managing the risks via a security of debt-like instruments. This could provide superior investment outcomes over a fund cycle, while addressing complex funding needs of investee companies more effectively. While it may not be suitable for all situations like buyouts or early-stage funding where risk capital is required, private credit has the potential to serve a larger market need, which might be currently served by traditional debt or in some cases pure equity.
 

Given its ability to supplant traditional and alternative pools of capital at both ends of the debt and equity spectrum, and also help anywhere in between, it has the potential to become the preferred choice for many private capital needs. And in the process of this transition, private credit can evolve from being a mere ‘private credit fund’ to truly becoming a ‘private capital fund’.

Nilesh Dhedhi is MD & CEO, Avendus Finance Private Limited.
Niyati Tanna is ED, Avendus Private Equity Investment Advisors Private Limited