Direct lending funds: borrow from an investment fund instead of a bank

Direct lending funds pool investor capital and lend it directly to companies. They can offer more flexible structures than traditional banks, especially for established businesses with assets and a trading history, but the borrower still faces detailed due diligence, interest, fees and possible security.

The lender is a professionally managed investment fund

The British Business Bank describes a direct lending fund as a managed pool of investor capital used to provide debt finance to businesses. Investors earn returns from interest, fees and charges paid by borrowers.

The borrower usually negotiates with the fund manager rather than a high-street bank. Lending criteria vary materially between funds.

Direct lending commonly targets established companies

British Business Bank guidance says direct lending is often suited to established businesses with assets and a trading history. Funds can fill gaps where banks are unwilling to provide the required structure or amount.

Prepare detailed financial history and forecasts. Flexibility does not mean the manager accepts weak information.

Debt can be tailored more flexibly than a standard bank loan

A fund can structure amortisation, bullet repayment, covenants or security around the business and transaction. This can suit acquisitions, growth or refinancing.

That flexibility has a price. Compare margin, fees and covenant package with bank and private-equity alternatives.

Assets and guarantees can still be at risk

Direct-lending debt can be secured against property, receivables or other business assets. Personal guarantees can also appear depending on the deal.

Review priority with existing lenders. A new fund cannot simply take first-ranking security over assets already pledged elsewhere without legal arrangements.

Expect detailed operational and financial due diligence

The fund manager can review management quality, customers, forecasts, debt capacity and security. Larger deals can involve advisers and substantial documentation.

Use the process to clean up reporting before approaching the fund. A company seeking flexible capital should still be able to produce reliable monthly accounts and cash forecasts.

Treat the facility as part of the permanent debt stack

Add the fund to the debt register with maturity, interest, fees, covenants and security. Direct lending can sit beside bank debt, mezzanine or equity, so cross-default and intercreditor terms matter.

Plan refinancing well before maturity. A bullet loan that looks easy today can create a large future cash requirement if the business assumes it will simply be rolled over.

Worked example: an established manufacturer needs £8 million for an acquisition but its bank will provide only £4 million under existing leverage policy. A direct lending fund can offer a larger, more bespoke facility with different amortisation or a bullet maturity. The company should compare the higher flexibility with the fund's pricing, security and covenant package.

Direct lenders can be faster decision makers because one fund manager controls the credit process, but larger transactions still require diligence, legal documentation and security perfection. Management should budget transaction costs and not assume "non-bank" means informal.

Pay attention to maturity concentration. A bullet repayment can preserve cash during the growth period but creates refinancing risk later. Add a refinancing start date to the debt calendar at least many months before maturity and monitor whether leverage is moving toward a level that future lenders will accept.

Compare information undertakings with management capacity. Direct lenders can require monthly reporting, compliance certificates, budgets and lender calls. A company accepting bespoke debt should be able to produce those reports reliably; repeated late reporting can become a covenant problem even when cash repayments are current.

Review transfer provisions as well. Fund loans can be sold or transferred to another institutional investor under the facility terms. Management should understand whether lender relationship quality depends on one fund manager who may not remain the creditor for the full term.

Model covenant headroom under the lender's definitions, not management's own EBITDA measure. Direct-lending agreements can contain adjustments, caps and exclusions that differ from board reporting. A company can believe leverage is comfortable while the contractual calculation sits much closer to the limit.

Worked example: a fund offers £10 million with only 2 percent annual amortisation and a large bullet at year five. The light early repayments support growth, but most principal still needs refinancing or cash repayment at maturity. Treasury should reserve for that future event and avoid treating low monthly amortisation as evidence the debt is cheap.

Also compare call protection and prepayment fees. A company that outperforms and becomes bankable after two years may want to refinance at a lower rate. Minimum interest or make-whole provisions can reduce the savings, so exit economics should be reviewed before signing the original facility.