Direct lending is the provision of private credit directly to small and middle market companies (SMEs) for the purpose of growth or acquisitions.
With banks reducing their supply of loans, new sources of finance have developed. For the smaller loan sizes, peer-to-peer (P2P) and new asset-backed providers have come to play a useful role. Banks have returned to lending markets, but the new regulations they operate under, have reduced their relevance to SMEs.
The financing gap in combination with low interest rates has attracted many institutional investors such as pension and sovereign wealth funds to invest into the direct lending markets. The main problem that the direct lending market faces is not a lack of capital investment but the lack of commercial awareness by SMEs. A recent Grant Thornton survey highlighted that 73% of lenders see the lack of awareness and understanding about non-bank lending, even among the larger SMEs, as the main obstacle for the growth of this market.
The lending structure offered by private capital is typically more flexible than what banks can offer. Direct lending still provides traditional lending structures such as senior, mezzanine and bridge funding. Additional structures offered by direct lending include acquisition funding. Finally, capital is available for supporting fast growing business in a non-dilutive way.
Recent estimated amount of direct deals for middle market companies not owned by private equity firms, with the purpose of growth, acquisitions and refinancing stands at around 300 to 400 transactions annually. However, this is just the tip of the iceberg as many smaller companies with a turnover of less than €25 million are difficult to track.
The European Central Bank estimates that there is around €2 trillion of loans, which are either outstanding, will need refinancing or newly required by more than 25,000 European companies, with a turnover ranging from €75 million to €1 billion. For the millions of companies with a turnover of less than €75 million a further €2.4 trillion will be required.