Glossary

Direct Lending

Direct Lending

Here at Nucleus, we champion small businesses. In fact, we've won awards for doing so. As one of the top direct lending firms, our commercial finance products have helped SMEs like yours find alternative funding options.

Offering a variety of financial solutions, discover what direct lending is, how it can help you achieve your business goals, and how we can support you with the finance your business needs in order to flourish.

What is direct lending?

Direct lending companies work by providing capital to small and middle-market companies (SMEs) to help them grow. A direct lending fund acquires its capital through a number of investors, including wealthy individuals, asset management firms, business development companies and even peer-to-peer crowdfunding. This pool of money then provides debt finance to businesses in need.

In recent years, mainstream banks have been reducing the number of business loans they offer to SMEs and start-ups because of the potential risk that's involved.

This has led to private lenders making loans to businesses without using an intermediary, such as an investment bank or broker. Because of how easy it is to apply for a direct lending fund, they are fast becoming a popular way for businesses to raise the capital they need.

How does direct lending work?

Direct lending funds contain capital raised by asset managers from a variety of investors and can be contracted in three ways:

  • -First lien: The loan must be paid off by the borrower before any other debt types.
  • -Second lien: Can be either cash-flow loans or asset-based loans. Once a first lien loan is in place, a second lien loan can be applied for. If the company goes bankrupt, the first lien loan must be paid back first, then the second, making second lien lending riskier for investors.
  • -Unitranche debt: A hybrid loan structure that combines both senior and junior debt. This direct lending fund structure increases the flexibility of the lending terms and provides greater access to capital for businesses.

Direct lenders operate as a single entity, whereby you apply to one company for a loan and they either grant you a loan or not. Whereas traditional lending uses a broker, who will reach out to several lenders on your behalf.

Direct lending firms will often have fund managers who are responsible for individual cases and will be your first point of contact. Before you approach a direct lending facility, you should make sure all your business financials and business history are in order as these will be important for securing the direct lending funds you require.

If they think your business is suitable for direct lending, the fund manager assigned to you will carry out a more detailed investigation where they will look at how the business operates too. Based on that due diligence, they will then decide whether to lend you money and what the terms of the agreement will be.

What companies benefit from a direct lending fund?

There are 5.8 million small businesses in the UK and this figure is only set to rise. While traditional lenders like banks are providing business loans to SMEs, direct lending partners still make up the majority of business loans. In fact, in the first half of 2019, £12.2 billion was lent to small businesses, with SMEs based in London and South East receiving around 40% of all SME loan capital.

It's for this reason that SMEs are the ones who benefit the most from a direct lending fund, and direct lenders still favour this middle-market too since it's one of the biggest investment pools, with 99% of all UK businesses classified as an SME.

What can direct lending funds be used for?

Direct lending funds can be used in myriad ways to support your business' growth. If you run a fast-growing business, using debt to support your growth could be the solution you've been looking for. Unlike equity, debt has a specified interest rate and a schedule of dates when interest is to be paid.

Debt can be used to finance a wide variety of business activities including refinancing existing debt, funding future growth, raising capital to support M&A, or just raising debt to address shareholder opportunities.

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    Direct lending FAQs

    What are the benefits of direct lending?

    • -Flexibility: Direct business lending terms tend to be more flexible than traditional financing. Unlike brokers who will often present their clients with the best deal based on the amount of commission they will make, direct lending partners will provide the best product that fits your business need.
    • -Great for start-ups: Many start-ups don't have the financial history to provide evidence that their business is profitable and therefore a sound investment, however direct lenders can often create an option that works for both the business and the investors, even if the business owner has a bad credit score.
    • -Easy application process: Unlike traditional ways of raising capital, applying for direct lending is a relatively quick and easy process.
    • -Closer relationship: When going through a broker you only deal with the broker and not the end lender. With direct lending, you work closely with your chosen firm and they get to know you and your business. If you require further funds they already have the documentation.
    • -Quick cash release: Most top direct lending firms operate online, meaning you can access your account 24/7 and aren't restricted to normal business hours – ideal for SMEs where time is precious. Transactions are often faster than traditional lenders too.
    • -More favourable terms: Banks secure their loans with high-interest rates and fees to mitigate any risk that's involved in lending to small businesses, but direct lenders can work personally with the borrower and create more favourable and potentially bespoke repayment terms.

    What are the drawbacks of commercial direct lending?

    • -Charges: Like any formal debt financing, if you're late with repayments or miss any, you may be penalised with a fee.
    • -Impacts credit rating: If you default on repayment, this may affect both your personal and business credit report.
    • -Business or property at risk: If you've secured your loan with any assets, such as your property, they may be at risk if you default on your repayments.
    • -Potentially more work: When you use a broker you only need to complete one application form, and they then approach lenders. With direct lending, if you are rejected, you have to submit a new application to each direct lending company which could take time.
    • -Hard to compare rates: Direct lending firms provide you with one loan product that fits your needs. To compare rates you'll need to submit multiple applications to a number of lenders.
    • -What is the interest rate and is it fixed?
    • -How long do I have to repay the loan?
    • -Are there charges for repaying in full before the term ends?
    • -Is the capital secured against assets?
    • -Are the repayment terms affordable?

    What do I need to consider before choosing a direct lending facility?

    Before borrowing money from a direct lender there are some things you should consider:

    • -What is the interest rate and is it fixed?
    • -How long do I have to repay the loan?
    • -Are there charges for repaying in full before the term ends?
    • -Is the capital secured against assets?
    • -Are the repayment terms affordable?

    How can Nucleus help?

    If you'd like to know more about how Nucleus can help with funding, then get in touchwith ourteam of friendly advisers and discover how we can help you. The eligibility criteria and application process behind our business loan products vary, so it's worth talking with us, so we can better understand your business needs.

    Explore the types of funding we offer and see how we can help your business grow.


    BY Jessica Lambert

    4 August, 2022

    3MIN

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