Private credit vs. private equity comes down to one legal relationship: with private credit you are a lender, and with private equity you are an owner. Both channel money into companies that aren’t traded on public stock exchanges, but that single difference — creditor or shareholder — decides how you earn a return, how you’re taxed, how long your money is tied up, and where you stand if the company fails.
Lender or Owner: The Underlying Relationship
Private equity buys shares in a company. Those shares carry governance rights typically laid out in a shareholders’ agreement, including the ability to appoint directors, approve or block mergers, and hire executives. The plan is to increase the company’s value through operational and strategic changes, then sell the stake for more than was paid.
Private credit lends money to a company under a credit agreement. Investors hold no shares, cast no votes on corporate decisions, and have no seat at the board table. What lenders have instead are covenants — contractual conditions the borrower must follow. Negative covenants restrict actions like taking on more debt or selling major assets without approval; affirmative covenants require actions like delivering regular financial statements. If the borrower breaches a covenant, the lender can declare a default, accelerate the loan, or renegotiate terms, even when no payment has been missed.1BlackRock. Covenants: Translating Jargon of Private Credit
Equity investors get their information a different way. Because they are part-owners, they typically have contractual and statutory rights to inspect books, records, and financial data. Both Delaware and New York law grant shareholders the right to inspect corporate records for purposes reasonably related to their ownership interest, which matters because private companies aren’t required to publish the financial reports that public companies are.
How Returns Get Paid
The income patterns are almost opposites. Private credit produces a stream of scheduled payments; private equity produces a lump sum only when the investment is sold.
Private credit returns follow the payment schedule written into the loan. The borrower pays interest, either at a fixed rate or a floating rate tied to a benchmark such as the Secured Overnight Financing Rate,2Federal Reserve Bank of New York. Secured Overnight Financing Rate Data and repays the full principal at maturity. Because those payments are legal obligations, missing them triggers consequences that can escalate to seizure of collateral.
Some private credit deals include payment-in-kind (PIK) interest, where the borrower defers cash interest and instead adds it to the loan’s principal balance. A $1 million loan at 10 percent with PIK terms would grow to $1.1 million after one year, with future interest calculated on the higher balance. PIK boosts nominal yield, but it also means the borrower’s total debt quietly increases over time, which adds risk if the company weakens.
Private equity returns depend on the company gaining value. Investors realize profits only when they exit — usually by selling to another firm, taking the company public through an IPO, or recapitalizing the business. Some portfolio companies distribute dividends, but those are at the board’s discretion. Total return is simply the difference between the purchase price and the exit value, so a poorly performing company can return less than the original investment, or nothing.
Where You Stand if the Company Fails
The order in which creditors and owners get paid is the sharpest practical difference between the two.
Private credit sits near the top of the capital structure. Under the absolute priority rule in bankruptcy, creditors are paid before equity holders. Senior secured lenders — the most common private credit position — are first in line, and their claims are backed by collateral such as real estate, equipment, or intellectual property. Lenders protect that priority by filing a UCC-1 financing statement, which puts other potential creditors on notice of the security interest.3Legal Information Institute. UCC Financing Statement
Equity sits at the bottom. Shareholders receive distributions only after every creditor — secured lenders, unsecured bondholders, employees owed wages, and tax authorities — has been paid in full. If the company’s assets don’t cover its total debt, equity holders lose the entire investment with no legal recourse. That downside is the trade-off for the higher potential upside ownership provides.
How Long Your Money Is Locked Up
Neither asset class offers the liquidity of a public stock exchange, but their timelines differ in both length and predictability.
Private credit investments have a contractual maturity date by which the loan must be repaid. The average maturity has generally been around five years, though individual loans run shorter or longer. Borrowers may repay early, but credit agreements often include prepayment penalties or make-whole provisions that compensate the lender for the interest income it would otherwise have earned.4Federal Reserve. Private Credit: Characteristics and Risks
Private equity has no set maturity. Investors wait for a liquidity event — a sale, an IPO, or a recapitalization — to convert ownership into cash. That commonly takes seven to ten years and can stretch longer when market conditions are unfavorable. Nothing forces the company or the fund manager to create a liquidity event on any particular date.
If you need to exit before then, you can try to sell your interest on the secondary market. A market exists for stakes in both private equity and private credit funds, but sellers typically accept a discount to reported net asset value. Research has shown average discounts in the range of 10 to 15 percent, and the transaction depends on finding a willing buyer, which can take months.
How the Income Is Taxed
The tax treatment of the two return streams is very different, and it moves the after-tax comparison.
Interest income from private credit is generally taxed as ordinary income at your marginal federal rate, which can reach 37 percent for high earners. This is the same treatment that applies to bank interest or bond coupons. PIK interest is typically taxable in the year it accrues to the principal balance, even though no cash has changed hands.
Private equity profits are usually taxed at the long-term capital gains rate — 0, 15, or 20 percent depending on taxable income — if the investment was held more than a year. High-income investors may also owe the 3.8 percent net investment income tax on top.
Fund managers on both sides often receive a share of profits called carried interest. Under federal tax law, carried interest qualifies for long-term capital gains treatment only if the underlying assets were held more than three years, not the standard one-year period.5Office of the Law Revision Counsel. 26 U.S. Code 1061 – Partnership Interests Held in Connection With Performance of Services Any gain on assets held three years or less is reclassified as short-term and taxed at ordinary rates. That three-year rule hits private credit managers harder, because many loans mature in around five years and some are refinanced earlier, making the holding period harder to satisfy than in private equity, where investments routinely last seven to ten years.
Fees You’ll Pay
Both types of funds typically charge a management fee plus a performance fee, and both reduce your net return.
The traditional “two and twenty” model is a management fee of roughly 2 percent of assets under management per year, plus carried interest of about 20 percent of profits. Managers with strong track records sometimes command carried interest as high as 30 percent. These figures aren’t fixed across the industry; they’re negotiable and vary by fund.
Many funds also apply a hurdle rate, or preferred return — commonly around 8 percent — that the fund must deliver to investors before the manager collects any carried interest. If the fund doesn’t clear the hurdle, the manager earns only the management fee. Private credit funds tend to have modestly lower fee structures than private equity funds because lending involves less operational work than buying and restructuring companies, though the specifics vary widely by fund.
Who Is Allowed to Invest
Both private credit and private equity funds are sold through private placements exempt from full SEC registration, so they aren’t available to the general public. Federal securities law limits participation to investors who meet specific financial thresholds.
Most funds require investors to be accredited investors. For individuals, that means net worth above $1 million excluding a primary residence, or annual income above $200,000 ($300,000 with a spouse or partner) for the prior two years with a reasonable expectation of the same this year.6U.S. Securities and Exchange Commission. Accredited Investors Certain professional certifications and institutional status also qualify.
Some larger, more exclusive funds require the higher qualified purchaser standard — generally an individual or family entity owning at least $5 million in investments, or an investment manager overseeing at least $25 million. These funds operate under a different exemption from the Investment Company Act, which lets them pursue a wider range of strategies with fewer regulatory constraints.