Private credit and direct lending

What direct lending is

Direct lenders make loans to companies without going through the syndicated loan or bond markets. The typical borrower is a mid-sized business, often owned by a private equity sponsor, borrowing to fund an acquisition, a refinancing or growth. The loan is usually senior secured and floating rate, priced as a spread over a base rate.

Because the lender holds the loan rather than selling it, underwriting is the whole game. There's no market to exit into if the credit goes wrong, so the lender has to be right about repayment at the start and protected by the documents if it isn't.

Common structures

What the lender underwrites

• Cash flow. Does EBITDA, after capex, taxes and working capital, comfortably cover interest and scheduled principal?
• Durability. How did the business perform in its worst historical year? How concentrated are its customers and suppliers?
• Leverage and value. How much debt sits ahead of and alongside this loan, and how much equity cushion is underneath it?
• The sponsor. Track record, the size of the equity cheque, and willingness to support the company in a downturn.
• The documents. Covenants, baskets and definitions that decide whether the lender gets a seat at the table early.

Key metrics

Typical risks

• Cyclical demand or input-cost swings that compress margins faster than prices can adjust.
• Customer concentration, where losing one contract changes the credit.
• EBITDA adjustments in the definitions that flatter leverage and loosen covenants.
• Baskets that let value leave the credit through dividends, incremental debt or asset transfers.
• Other debt maturing before the loan, creating a refinancing wall.

Questions an IC will ask

• What happens to leverage and liquidity if the company has its worst historical year again?
• How much EBITDA comes from adjustments, and would we lend against the unadjusted number?
• Which baskets could let value leave the credit, and how large are they?
• Is the sponsor likely to support the company with more equity if it struggles?
• Are we being paid enough compared with similar loans?
• If the business is sold or refinanced early, what do we earn, and is there call protection?

Common memo mistakes

• Using last year's leverage instead of pro forma leverage for the new structure.
• A downside that trims EBITDA a little instead of replaying the company's own worst period.
• Describing covenants instead of judging whether they would catch trouble early.
• Ignoring liquidity: a company can be covenant-compliant and still run out of cash.
• Pricing commentary that doesn't compare the spread with the risk taken.

Practice on a direct lending case, and see How to write an IC memo for structure.

Not every private credit loan is a sponsor cash-flow loan. For lending against pools of assets, contracted projects, a planned take-out or recurring revenue, see the primers on asset-based and specialty finance, infrastructure, bridge financing and AI and tech lending.