Debt vs. Equity Risk: Are You Getting Debt Returns for Equity Risk?

Private credit is booming, but not all debt investments are created equal. Some lenders are learning the hard way that their secured loans can turn into equity stakes without the upside, which is why is important for investors to understand the underlying assets and risks when investing.

Debt versus Equity Risk

Debt should mean security: a fixed return, priority over equity holders, and collateral backing. But some investors can wake to a different reality—holding the keys to underperforming businesses instead of steady income.

Take Metrics Credit Partners and Pacific Hunter Group (owner of Rockpool and Sake). Metrics was the lender, but ended up having to take control of the company in late 2024 to protect their debt investment and is now a lender managing a restaurant business. Another example is in construction lending, where if the project encounters financial difficulties, the lender may need to step in to appoint its own receivers and developers to complete a project. What started as a “lower-risk” debt investment for investors morphed into a higher-risk equity position—without equity-level returns.

This isn’t a one-off. Defaults happens in lending, so how a lender can recover capital when a loan is non-performing is key to understand for the risk on your investment.

What Investors Need to Watch

Not all secured debt is equal and has the same level of risk. Here’s what to look for:

✅ Loan-to-Value Ratio (LVR): the lower the LVR = the bigger the buffer before investors take a hit. Equally important to that is quality of the independent valuation done.

✅ Covenants: strong covenants flag risks early and give lenders control before things go off the rails.

✅ Quality of Collateral: If the borrower defaults, can the asset be sold quickly and at full value? Or does the lender need to step in to manage a construction project or business?

✅ Exit Strategy: if the borrower can’t refinance, what happens next? Is the lender able to sell the asset immediately?

Capstone’s Approach

At Capstone Funds, we don’t take unnecessary equity risks. Our loans are:

✔️ Backed by property – all our loans are backed by Australian property along the Australian eastern seaboard. We do not have any major construction exposure and properties are generally non owner-occupied. This makes it a simpler process to sell a property to recover capital if required – compared to business lending, if we need to take over an asset our exit strategy is to sell the property rather than manage a business

 ✔️ Strong risk management - we invest in high-quality property assets with conservative LVRs. We also align with our investors by putting in our own capital as a first loss to investors – meaning our capital is at risk first

✔️ Diversified – we invest in a diversified pool of loans, spreading risk

Private credit should offer predictable, risk-adjusted returns. When investing into private debt, look at the underlying asset and consider where you would want the lender to be operating that asset, and consider whether the risk to return is right for you.