What Is A Private Credit Fund and How It Works (2025 Guide)

It’s crazy how many high-income professionals have their money sitting in traditional portfolios earning 2-4% while private credit funds are generating 7-12% returns for those who know how to access them.

This article is for educational purposes only and reflects the opinions of the authors. It is not financial, legal, or tax advice. Always consult qualified professionals before making investment or legal decisions.

If you’re tired of watching your wealth grow at a snail’s pace while inflation eats away at your purchasing power, you’re probably wondering what the wealthy know that you don’t. The answer? Private credit.

We’re Palmy and Nancy Kitti — your financial BFFs and alternative investment go-to source. Having closed 10 deals and raised $130 million in capital, we’ve seen firsthand how private credit fits into a sophisticated wealth-building strategy. Today, we’re breaking down exactly what private credit funds are, how they work, and why they might be the missing piece in your transition from earned to owned income.

What Is A Private Credit Fund?

A private credit fund pools capital from accredited investors to provide loans to privately held companies, essentially becoming the bank for businesses that can’t or don’t want to use traditional lending channels.

Think of it this way: when a company needs $50 million to expand their operations, they have options. They could go to a bank (if they can get approved), issue public bonds (expensive and time-consuming), or work with a private credit fund that can move fast and structure creative deals.

Here’s where it gets interesting for investors like you. Instead of owning shares in a company and hoping the stock price goes up, you’re essentially becoming the lender. Your returns come from interest payments — steady, predictable income that typically ranges from 7-12% annually according to iCapital Insights.

Unlike private equity, which seeks ownership and capital gains through buying and selling companies, private credit focuses on fixed income-like returns from interest and principal repayment. You’re not betting on a company’s explosive growth; you’re getting paid for providing capital.

How Private Credit Funds Work: The Complete Process

The private credit process unfolds in four distinct phases, each designed to generate consistent returns while managing risk.

Phase 1: Capital Raising and Fund Formation

Private credit managers start by raising capital from institutional investors, family offices, and high-net-worth individuals. The fund typically has a target size — say $500 million — and a specific investment strategy focused on direct lending, asset-backed financing, or distressed debt.

Once the fund reaches its target, it closes to new investors and begins deploying capital. This is rather like assembling a team before starting a major project — you need the right resources in place before you can execute.

Phase 2: Deal Sourcing and Underwriting

This is where the magic happens. Fund managers identify companies that need capital, often through relationships with private equity firms, investment banks, or direct business development.

The typical scenario? A private equity firm buys a company for $100 million, putting up $40 million in equity and needing $60 million in debt financing. Instead of going to a traditional bank, they work with a private credit fund that can:

• Move faster than banks (weeks instead of months)
• Offer more flexible terms
• Provide larger loan amounts
• Structure creative deals

During underwriting, managers analyze the borrower’s financial health, cash flow, industry dynamics, and collateral. They’re looking for companies with stable cash flows that can service debt payments reliably.

Phase 3: Loan Structuring and Negotiation

Here’s where private credit gets sophisticated. Unlike a simple bank loan, these deals often include:

Floating Interest Rates: Typically structured as a spread over SOFR (Secured Overnight Financing Rate). For example, SOFR + 6%, meaning if SOFR is 4%, you’re earning 10% on that loan.

Covenants: Financial guardrails that protect lenders. If the company’s debt-to-EBITDA ratio gets too high, they might need to pay down debt or get lender approval for major decisions.

Collateral: Senior loans are typically secured by the company’s assets, giving lenders first-in-line repayment priority if things go sideways.

Original Issue Discount (OID): Sometimes loans are issued at 98 cents on the dollar but pay back at 100 cents, creating additional return.

Phase 4: Portfolio Management and Returns

Once loans are deployed, the real work begins. Fund managers actively monitor each borrower’s performance, reviewing monthly financials, conducting quarterly business reviews, and maintaining constant communication.

When loans perform as expected, investors receive quarterly distributions from interest payments. As loans mature (typically 3-7 years), principal gets repaid and redeployed into new opportunities.

Some structures like Business Development Companies (BDCs) trade publicly and offer more liquidity, while traditional private credit funds have lock-up periods of 5-8 years.

Private Credit vs. Other Investment Strategies

Private Credit vs. Traditional Fixed Income

Public bonds and traditional fixed income investments are like shopping at a department store — everything is standardized, priced efficiently, and available to everyone. Private credit is more like working with a custom tailor — higher cost, but potentially much better fit and results.

Traditional fixed income might yield 4-6% in today’s environment, while private credit targets 7-12%. The trade-off? Liquidity and complexity.

Private Credit vs. Private Equity

This is like comparing a steady rental property to a house flip. Private equity buys companies, improves operations, and sells for a profit — high risk, high reward, with returns dependent on successful exits. Private credit lends money and gets paid interest — lower risk, more predictable returns, with first-in-line repayment priority.

One of our LP investors shared a perfect analogy: “Private equity is like being a business owner. Private credit is like being the bank that lends to the business owner.”

Private Credit vs. Real Estate Syndications

Both are alternative investments targeting accredited investors, but they work differently. Real estate syndications pool money to buy physical properties, generating returns through rental income and appreciation. Private credit lends money to companies, generating returns through interest payments.

Real estate gives you exposure to a tangible asset and potential inflation hedge. Private credit gives you senior position in the capital stack and more predictable cash flows.

Types of Private Credit Strategies

Not all private credit is created equal. Understanding the different strategies helps you evaluate opportunities and align them with your risk tolerance.

Direct Lending (Senior Debt)

This is the bread and butter of private credit. Fund managers provide senior loans to established companies, typically secured by assets and carrying first-in-line repayment priority.

Expected returns: 7-12% with relatively lower risk

Loan-to-value ratios: Usually 50-70%

Typical borrowers: Profitable middle-market companies

Mezzanine Financing (Subordinated Debt)

Mezzanine sits between senior debt and equity in the capital stack. Higher risk than senior debt, but higher returns, often including equity kickers like warrants.

Expected returns: 10-15%

Typical structure: Fixed interest plus equity upside

When it makes sense: Growth companies that need flexible capital

Asset-Based Lending

Loans secured by specific assets like equipment, inventory, or receivables. Asset-backed private credit loans expect 10-12% returns over 5-8 years, secured by collateral like planes or income streams, according to iCapital Insights.

The collateral provides additional protection, but requires specialized expertise to value and manage.

Distressed and Special Situations

Higher-risk, higher-reward lending to companies in financial distress or unique situations. Requires significant expertise and higher minimum investments.

This is like being the person who buys foreclosed homes — potentially lucrative, but you better know what you’re doing.

The Private Credit Opportunity: Why Now?

Private credit has exploded since 2008, and it’s not by accident. Several forces have created a perfect storm of opportunity:

Bank Regulation Changes

Post-2008 banking regulations made it harder and more expensive for banks to make certain types of loans. This created a massive financing gap that private credit funds stepped in to fill.

It’s rather like when your local bank stopped making construction loans — someone else had to provide that capital, creating opportunity for those willing to fill the void.

Private Equity Growth

The private equity industry manages over $4 trillion in assets, and many of those deals need debt financing. Private credit funds have become the go-to source for this capital.

Interest Rate Environment

With many private credit loans carrying floating rates, rising interest rates actually increase returns for lenders. While this hurts borrowers, it benefits private credit investors.

One thing we’ve learned in our 7+ years in alternative investments: when traditional sources of capital retreat, opportunities emerge for those positioned to provide it.

Risks and Considerations

Let’s be real — private credit isn’t without risks. Understanding them upfront helps you make informed decisions.

Liquidity Risk

This is the big one. Unlike stocks or bonds, you can’t just sell your private credit investment when you need cash. Most funds have 5-8 year lock-up periods, and even BDCs can impose redemption gates during stress periods.

Trust me when I tell you — never invest money in private credit that you might need in the next 5 years.

Credit Risk

Companies can default. While senior loans have better recovery rates than equity investments, you’re still lending to private companies that may not have public credit ratings.

Recent stress has appeared in software loans trading below 80 cents on the dollar, according to recent market data. Due diligence on fund managers and their underwriting process is critical.

Portfolio Drift

Here’s something many investors don’t realize: mature funds can evolve beyond their original strategy. Senior debt exposure can erode due to equity kickers and restructurings, boosting private-credit factor risks over public correlations, according to MSCI Research.

Young private credit funds correlate 0.64 with public portfolios, while mature diversified funds correlate only 0.25. This can be good for diversification, but it means your investment may behave differently than expected.

Concentration Risk

Many funds concentrate in specific sectors or deal sizes. If you’re investing in a fund focused on software companies, and the software sector hits headwinds, your entire investment could be affected.

How to Evaluate Private Credit Opportunities

Not all private credit funds are created equal. Here’s what we look for when evaluating opportunities:

Manager Track Record

This isn’t just about returns — it’s about performance across different market cycles. How did they handle the 2020 COVID crisis? What was their loss rate during the 2015-2016 energy downturn?

Private credit funds with over $150 million in assets must register with the SEC under the Investment Advisers Act, providing additional oversight.

Investment Process

Understand how they source deals, conduct due diligence, and manage risk. The best managers have systematic approaches and deep industry relationships.

Fee Structure

Typical fees include a management fee (1-2% annually) plus a performance fee (10-20% of profits). Make sure you understand all costs upfront.

Diversification Strategy

Look for funds that diversify across:

• Industries and sectors
• Company sizes
• Geographic regions
• Loan types and seniority

Diversification via senior, collateral-backed loans is emphasized amid tightening liquidity conditions.

Private Credit in Your Portfolio

For first-generation wealth builders making $200K-$2M annually, private credit can play several roles:

Income Generation

With quarterly distributions from interest payments, private credit can provide steady cash flow to supplement earned income.

Diversification

Low correlation with public markets means private credit can reduce overall portfolio volatility while potentially increasing returns.

Inflation Protection

Floating-rate loans adjust with interest rates, providing some protection against inflation — something fixed-rate bonds can’t offer.

Wealth Transition Tool

Private credit helps transition from earned income (your salary) to owned income (investment returns), which is scalable and doesn’t require trading time for money.

Just ask our acupuncturist — her husband told her, ‘Thank god we aren’t retiring right now, because if we had to retire today relying on stock portfolio, we probably can’t.’ That’s why you need to invest in the private market — where real wealth is built today.

Getting Started with Private Credit

Ready to explore private credit? Here’s your action plan:

Step 1: Verify Accredited Investor Status

Most private credit opportunities require accredited investor status ($1M+ net worth or $200K+ annual income).

Step 2: Assess Liquidity Needs

Only invest money you won’t need for 5-8 years. This isn’t your emergency fund or house down payment money.

Step 3: Start Small

Consider allocating 5-15% of your investment portfolio to private credit initially. You can increase allocation as you gain experience and comfort.

Step 4: Work with Experienced Operators

Whether through direct fund investment or platforms that provide access, work with managers who have deep experience and strong track records.

Remember, if you don’t build wealth intentionally, it’ll be built for you incidentally—and let’s be real, it probably won’t serve you.

FAQ: Private Credit Fund Essentials

What is the minimum investment for private credit funds?

Most private credit funds require minimum investments of $100,000 to $500,000, though some may accept lower amounts through feeder funds or platforms. At The Kitti Sisters, our minimum investment is $100,000, with our average LP investment being $200,000.

How long is money locked up in private credit?

Typical lock-up periods range from 5-8 years for traditional private credit funds. Some structures like BDCs offer more liquidity with periodic redemption windows, though they may impose gates during market stress.

What returns can I expect from private credit?

Direct lending strategies typically offer expected returns of 7-12% annually, while asset-backed lending and mezzanine strategies may target 10-15%. Returns come primarily from interest payments rather than capital appreciation.

How does private credit perform during economic downturns?

Private credit’s performance during downturns depends on the underlying loan quality and structure. Senior secured loans typically have better downside protection than equity investments, but defaults can still occur. Floating-rate structures can actually benefit from rising interest rates.

What’s the difference between private credit and private equity?

Private credit involves lending money to companies and earning returns through interest payments, while private equity involves buying ownership stakes in companies and earning returns through capital appreciation when selling. Private credit is generally considered lower risk with more predictable returns.

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This article is part of the Earned to Owned platform — built by The Kitti Sisters for first-generation wealth builders. Take the free Where Wealth Breaks assessment to find out where your wealth infrastructure has gaps.

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This article is part of the Earned to Owned platform by The Kitti Sisters. Take the free Where Wealth Breaks™ assessment — under 3 minutes.