Private Credit: What Investors Should Know Before Investing
Private credit has grown from a niche corner of institutional investing into a topic many high net worth investors now ask about. The idea is simple: instead of buying publicly traded bonds, investors lend money directly to companies, often through a fund, and earn interest in return. The details, however, are anything but simple.
Private credit investing can offer income and diversification potential, but it also carries real risks, limited liquidity, and tax consequences that are easy to miss. Before adding private debt to a portfolio, it is worth understanding how it works, where it may fit, and how it interacts with your broader wealth and tax plan.
Start Here: A Complimentary Wealth and Tax Review
Whether you are curious about private credit or already hold some, a coordinated review can show how alternatives fit with the rest of your financial life. Compound offers a complimentary, no-obligation wealth and tax review that may include:
Your current portfolio: allocation, concentration, income sources, and existing alternative holdings
Liquidity needs: how much of your wealth needs to be accessible in the next several years
Investor qualification: whether you may meet the requirements for private investments
Tax picture: how additional interest income may affect your taxes and which accounts may hold it
Long-term goals: retirement, business transitions, and legacy plans
Request your wealth and tax review.
What Is Private Credit?
Private credit refers to loans made by non-bank lenders to companies, typically middle-market businesses, outside of public bond markets. The loans are negotiated privately between the lender and the borrower, and they are usually not traded on an exchange.
Common types of private debt include:
Direct lending: senior loans to companies, often secured by business assets
Mezzanine debt: loans that rank below senior debt and may include equity features
Distressed and special situations: lending to or buying debt of companies under financial stress
Asset-based lending: loans backed by specific assets such as receivables, equipment, or real estate
Many private credit loans carry floating interest rates, meaning payments adjust as benchmark rates change. That can be attractive in some rate environments and less so in others.
Who Can Invest in Private Credit?
Most private credit funds are alternative investments available only to qualified investors, such as accredited investors or qualified purchasers, under securities rules. Some vehicles, such as certain interval funds and business development companies, have different access requirements, but they still carry many of the same risks. Eligibility rules are set by regulators and can change, so it is worth confirming your status before evaluating an offering.
What Are the Risks of Private Credit Investing?
Higher potential income generally comes with higher risk. Investors should understand:
Illiquidity. Many private credit funds limit withdrawals, sometimes for years. Interval funds may allow periodic redemptions, but they can limit or suspend them. You should be prepared to hold the investment for its full term.
Credit risk. Borrowers are often smaller or more leveraged than companies that issue public bonds. Defaults can lead to partial or total loss.
Valuation risk. Private loans are not priced daily by a market. Reported values rely on estimates and may lag real conditions.
Concentration and manager risk. Results can depend heavily on a single manager's underwriting and the loans in one fund.
Fees and complexity. Management fees, performance fees, and fund expenses can be meaningful. Offering documents are long and deserve careful review.
Economic sensitivity. In a recession, defaults may rise and recoveries may fall.
Our guide on what to consider when evaluating alternative investments covers due diligence questions in more depth.
How Private Credit May Fit in a Portfolio
For qualified investors, private credit is generally considered a complement to, not a replacement for, a diversified portfolio of public stocks and bonds. Questions worth discussing with your advisor include:
How much of your portfolio can you reasonably lock up for several years?
Does private credit duplicate risks you already hold, such as exposure to business owners or real estate?
How does it fit with other private market investments, such as private equity or real estate funds?
What role is it playing: income, diversification, or both?
Our articles on alternative investment wealth management and alternative investments for high net worth individuals explore how private assets can be integrated into a broader plan.
Tax Considerations for Private Debt
Interest income from private credit is generally taxed as ordinary income, which is often taxed less favorably than qualified dividends or long-term capital gains. A few tax points worth reviewing:
Asset location. Some investors consider holding income-heavy investments in tax-deferred accounts where available. Not every private fund can be held in an IRA, and some may create unrelated business taxable income.
Reporting. Some funds issue K-1s, which can arrive late and add complexity to your tax return. Others issue 1099s.
State filings. Partnership investments may create filing requirements in other states.
Income timing. Additional interest income may affect other parts of your tax picture, such as Medicare premiums in retirement.
This is why wealth management and tax planning and preparation belong in the same conversation when alternatives are considered.
See the Effect of Taxes on Growth
The Compound calculator can show how a hypothetical investment may grow over time and how tax assumptions change the result. Results are hypothetical and do not represent any private credit investment, but they can show why after-tax returns matter.
Serving Investors Across Wisconsin
Compound works with individuals, families, and business owners throughout Wisconsin, including Milwaukee, Madison, Green Bay, Appleton, Brookfield, Waukesha, Eau Claire, and La Crosse, as well as surrounding areas. As a fiduciary, Compound offers access to alternative investment opportunities for qualified investors as part of integrated tax and wealth planning.
Considering private credit? Request a complimentary wealth and tax review.
Frequently Asked Questions
What is private credit?
Private credit is lending by non-bank investors directly to companies, usually through funds, outside public bond markets. The loans are privately negotiated and generally not traded on an exchange.
Is private credit investing risky?
Yes. Private credit carries credit risk, illiquidity, valuation uncertainty, manager risk, and fees. Investors can lose some or all of their investment and may not be able to withdraw funds when they want.
How is private debt taxed?
Interest from private debt is generally taxed as ordinary income. Some funds issue K-1s and may create state filing requirements, so coordination with a tax professional is important.
Who can invest in private credit?
Most private credit funds are available only to qualified investors, such as accredited investors. Some registered vehicles have different requirements but carry similar risks.
Does Compound work with clients outside of Wisconsin?
Compound serves clients throughout Wisconsin and in surrounding areas. Availability of investment advisory services in a given state may depend on registration requirements.
Compound is a registered investment adviser. Registration does not imply a certain level of skill or training. This article is for informational and educational purposes only and should not be construed as personalized investment, tax, or legal advice. Tax laws are complex and subject to change. Strategies discussed may not be suitable for everyone, and there is no guarantee that any strategy will achieve its objectives or reduce taxes. Calculator results are hypothetical, are not guarantees of future results, and do not reflect any actual investment. Investing involves risk, including possible loss of principal. Diversification does not ensure a profit or protect against loss. Please consult your tax, legal, and financial professionals before acting on any information in this article. For more information, see Compound's Form ADV, available at adviserinfo.sec.gov.
About Compound Wealth
Compound Wealth believes many financial decisions benefit from being evaluated together rather than independently. The firm integrates tax planning, wealth management, accounting, and business advisory services to help clients navigate financial complexity through a coordinated planning approach tailored to their evolving needs.
