Can you please explain the difference between private equity and private credit? Fundamentally, private credit just means any lending to a company by an entity that's not a bank.

What sort of returns are we talking about in private equity versus private credit? You're trying to make at least, say, 15% IRR, and most firms are really targeting a higher level than that.

Does that mean that they could be two sides of that firm acting on the same deal? If you have an equity business and a credit business, you want those two things to operate fairly independently. So you shouldn't be financing one with the other.

Hi, Graham.

Hi, Debs. How are you doing? I'm great, but I've got an important question for you.

Can you please explain the difference between private equity and private credit? I know they sound similar.

They're careers that kind of sit next to each other, but what is the difference between them? Ooh, okay. A lot of similarities and a lot of differences.

I'm only going to do this at a high level to begin with, and I'm sure you're going to have some follow-up questions.

Fundamentally, the main difference is what are you investing in.

So private equity, private credit, we're both talking about private investment, so on the equity side, companies that don't trade on the public market.

On the credit side, we are making non-traded illiquid loans.

And fundamentally, private credit just means any lending to a company by an entity that's not a bank. So investing in illiquid loans or investing in companies that don't trade on the public market. Fundamentally, that is the difference.

Okay. So does that mean their investment process is different? Your motivations are different? Well, let's think about the difference in motivation between an equity investor and a credit investor.

An equity investor is at a very basic level.

Just think about public market equity investing.

You're trying to buy low and sell high.

You're trying to buy companies where you think there is some kind of value opportunity. I can buy something for 10 times EBITDA, grow EBITDA, hopefully sell it for 15 times EBITDA, right? I'm trying to access some kind of upside potential.

A credit investor has capped upside.

So when you make a loan to a company, you have a contract which says, "I am going to get repaid X," and generally not more than X, except for the case where you have some kind of equity co-investment or warrant or some kind of equity-like return.

But the way you make money in credit is by protecting your investment capital. Because you have this capped upside, what you really don't want to do is lose money. Of course, you don't want to lose money in an equity portfolio either. But in an equity portfolio, you can afford to have more losses because you might have a five or a 10 times return in your private equity portfolio. You're not going to have the same thing in a credit portfolio. So credit, you're participating for a capped return, and you're focused a lot more on preservation of capital and downside protection.

Okay. Now Finance 101 tells me that if you've got different risk profiles, you should expect different levels of return.

What sort of returns are we talking about in private equity versus private credit? It's a hard question to unpick, and I'll talk about why.

If we talk about the core asset level, even the core asset level in private equity is a little bit difficult to articulate because a lot of what private equity is doing is using leverage.

In other words, a lot of the loans that private credit is providing to increase equity returns. Let's talk about on a private equity fund where you're investing in some kind of levered asset, i.e.

leverage at the portfolio company level.

You're trying to make at least, say, 15% IRR, and most firms are really targeting a higher level than that.

On a credit asset, your actual asset level returns are probably high single digits, maybe 10%, when you think about some blend of SOFR or whatever your base rate is, plus your margin on the loan, plus some amount of upfront fee. And I say these things are difficult to compare sometimes because when you're making a private equity investment in a levered portfolio company, on the private credit side, a lot of times what you're doing to amplify your financial return is you obviously can't lever at the actual operating company. You can't lever a levered loan, but what you can do is lever the fund. So you basically go to a bank and say, "Hey, I've got this portfolio of 300 performing loans.

Can you provide me leverage against that pool of assets?" In this case, an asset is a loan.

In essence, when you fund a particular credit investment, if you're funding some of that with your own equity capital and some of that with debt capital that costs less than the loan that you're participating in, then you amplify your fund financial returns. And on the fund, you're probably targeting 12% to 15%, something like that.

Okay. And you mentioned in there the fact that for private equity deals, you've then got private credit providing the debt financing into that same deal. Does that mean that for a single private equity firm that also has its own private credit funds, they could be two sides of that firm acting on the same deal? And if so, do they actually interact with each other much? That's a good question. I don't know.

In my time in private credit, I didn't see any of that. So, I was at Ares for a decade.

Ares obviously has a private equity business.

We never looked at financing any Ares private equity portfolio company. I think the blurring of those lines is a little bit too murky, and I'm not saying you could never do this or should never do this, but I don't really know of a firm who does it in particular.

And I'd say generally speaking, the base case is if you have an equity business and a credit business, you want those two things to operate fairly independently.

So you shouldn't be financing one with the other.

Okay. But then I guess as a follow-on, when you were working on transactions, you were providing the credit for a leveraged buyout. What was your level of interaction with private equity? Were you kind of coordinating very closely? And even after the deal, was there a lot of interaction? Oh, from that perspective, very closely, because if you think about what private credit, let's say regular private credit or the majority of private credit has historically done, a lot of it is sponsor finance, so you're investing in levered loans for companies that are owned by financial sponsors. This is usually happening, say, on a sponsor's way into a deal on their purchase of that company, or it's some kind of refinance.

In any case, the two parties negotiating tend to be the credit provider and the equity owner.

I mean, obviously the company participates, but ultimately it's the owner that's making the ultimate decision about what kind of financing structure to take. So from that perspective, there's a ton of engagement.

So most of the time, if I think about the amount of time I spent on the phone or on emails, those phone calls, those emails were to financial sponsors and to lawyers.

Kind of the full trio, I suppose, of parties you need to actually get a deal done.

And how did the priorities of private equity differ to your priorities in private credit? Were you all singing from the same hymn sheet, or did you actually want different things out of the deal? Yes, and no. I mean, ultimately you have to have both parties that are-- both parties have to ultimately invest and want to invest in the same asset. Because if you think about private credit as really sponsoring private equity or supporting private equity rather, you have to have an investment hypothesis that both satisfies an equity investment hypothesis and a credit investment hypothesis.

And there are companies that do both.

You think about what is going to get you comfort in terms of downside protection as a credit investor, the visibility on revenue, businesses that have a lot of recurring revenue.

We talked about, say, software exposure and private credit and private equity.

A lot of that software exposure is there because those companies provide good visibility on revenue, on EBITDA.

Ultimately, you're looking for visibility on cash flow.

From an equity perspective, you can find companies that both do that and also have interesting growth prospects. So that's what's going to get the equity investor excited. So if you can and you do find companies that satisfy both, just from different perspectives.

Okay. So private equity, they're more focused on the upside, private credit, more focused on protecting against the downside.

Exactly.

That's interesting. And then from an actual skillset perspective, I know you were probably a superstar analyst with amazing skills when you were in private credit, but what is the difference in skillsets needed? If someone's thinking, "Should I look to get into private equity? Should I look to get into private credit?" What are the different skills that you think they would need? Okay. So in terms of the broad skills, they're very similar.

If you think about the deal process, deal comes in, I do diligence on a deal, a bunch of work to get myself comfortable.

That overall skillset is very similar on both sides.

I'd say the focus of that diligence tends to be a little bit different.

Again, on the equity side, you're focused on trying to identify the market opportunity, figure out how much can I grow this business, how much can I sell it for. On the credit perspective, you're trying to focus on all the areas where you think you can lose money and convince yourself that the risk that you're taking, you're getting paid for.

Everyone's always trying to maximize their risk-adjusted return.

In terms of the way those processes differ, I would say from an equity perspective, your deal process is probably a little bit longer.

If you're an associate in a private equity firm, you're probably doing more work on, say, a single transaction for a longer period of time.

In a credit shop, you're generally doing a little bit more volume.

So you'll do still a decent percentage of the diligence that the private equity firm is doing, but you'll be able to do more of those things more repeatedly.

So it kind of depends on how you're wired.

Do you like seeing a bit more flow and a bit more volume, or do you like getting really into the weeds on, say, one particular deal, one particular transaction? Me personally, so I was a generalist, so I looked at companies in pretty much every sector, and I thought that was kind of interesting because I learned how an agriculture business has something that's completely different from a business in technology, differing from a business in manufacturing, and I found it interesting just to look at a lot of those.

In an equity portfolio, especially now with equity being fairly specialized, you're more likely to be looking at, say, one industry in a lot of detail. So it kind of depends on how you're wired.

Okay. All right. And then I guess also if there's an analyst watching who's thinking, "Actually, I really enjoy modeling, I enjoy spreadsheet work," or, "I'm really interested in understanding businesses," is there a particular side that favors some of those skills, or is it kind of balanced across both? On that side, I think it's both. You're going to have to do all that work regardless of what seat you're sitting in.

As I said, if you're trying to get a lot of exposure to different businesses, you probably see a bit more flow on the credit side of things.

But as it relates to the actual work, I want to know how to model, I want to know how to do diligence, investment hypothesis building, all that kind of stuff, you're going to get that in both.

Okay, great. Final question for you, Graham.

Career pathways. Tell us about how you should get into private equity and private credit, and also what the opportunities are after that.

Again, I'd say they're very similar these days, and also different compared to, say, when we were both kind of in the market looking for jobs like this.

Like when I was an analyst at Lehman, the only way you could get into a job in private credit or private equity was by doing, say, an investment banking analyst program And then changing. Now you really have an opportunity to go to a lot of these places straight out of school. So I was just at my former employer doing their summer intern training. You can get a job at Ares right out of school.

That never used to be the case. So in terms of how to go about getting the job, it's going to be the same track for both.

And then in terms of ultimate kind of career progression, I'd say they're also, again, they tend to look very similar. If you think about the way these firms are structured, the way the firms are incentivized, the way the funds are structured, very detailed topics we can get into, and there are some important differences, but at a really high level, they tend to look very similar.

You're raising money from institutional LPs, limited partners of all types, gathering those assets, and then investing that equity capital either into purchasing companies outright or to making loans to those companies.

So kind of different investment focus.

But in terms of the overall process, they actually look pretty similar.

Okay. Actually, I do have one more question, if I can.

You've obviously seen investment banking and also the private markets, having worked in private credit.

What was the best thing about making that move? When I left Lehman Brothers, and I guess I can talk as much as I want about Lehman because it doesn't exist anymore, but when I left Lehman, I was working till two in the morning every day, and I was a young analyst looking for a better life.

And that was basically- Beautiful. ... that was almost it as it relates to my kind of career decision at that point.

I still worked a lot, but I didn't work until 2:00 a.m.

every night. So that was my main motivation for making the switch when I did anyway.

Okay, fantastic. Honestly, Graham, that was so interesting.

Loved hearing all of that, and I hope our listeners also enjoyed hearing about you talking through the differences between private equity and private credit, and learning a little bit more about the life of a private equity and private credit analyst. Thanks for listening.