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What is direct lending?
Direct lending funds offer a variety of debt products, to small and medium-sized businesses — without the help of intermediaries. Most of the debt products provided, are loans used for growth or acquisition purposes.
Like with conventional banking loans, borrowed money is repaid with interest and applicable charges — over the agreed term.
The direct lending market has become increasingly popular — as banks have tightened lending criteria and reduced loan supply.
Direct lending is also known as private credit, private debt or credit funds. It can be seen as a form of alternative business funding.
Direct lending — considerations
Direct lending funds allow businesses to get access to money — without going through traditional intermediaries i.e. brokers, investment banks and private equity firms. Borrowers tend to be smaller-sized companies or SMEs — who may not qualify for standard bank loans, cannot issue bonds or who are simply seeking better deals.
Direct lending funds are essentially funds where investors, attracted by the higher yields, pool their capital together. This capital is then used by professionally managed funds — to provide debt instruments to suitable companies.
Investors may be wealthy individuals, family offices, banks, pension funds, insurance companies etc. In a bid to boost lending to SMEs, government entities also invest — often in partnership with asset or fund managers. Investors earn returns through fees, interest and/or other charges — applied to the money lent to borrowers.
Direct lenders generally only lend amounts above a minimum threshold value, for example — five million Naira upwards. They typically hold onto loans issued for the long-term — keeping a close relationship with businesses they’ve lent to.
Unlike with conventional loans, debt products offered by direct lending funds, can be structured and tailored to a business’s needs. This includes having flexible repayment plans. Direct lenders are able to offer these bespoke debt products — due to not being constrained by regulatory capital requirements.
Debt crowdfunding or peer-to-peer lending (P2P) platforms, can be seen as a part of the direct lending market. In contrast to direct lenders — P2P platforms allow you to borrow both smaller and larger amounts of money.
How do direct lending funds work?
If your business is interested in borrowing from a direct lender — you would first need to look for a “fund manager”. Fund managers will need details of your company, its trading history, finances and forecasts. You’ll also need to give a full account of the purpose of the loan. Is it to purchase equipment? Is it for general growth? Or is it to finance an acquisition?
Each fund manager will have its own criteria, but they will all need to do detailed due diligence on your company — to asses credit risks. Some will only lend to businesses in a certain industry or of a certain size. Accordingly, it’s important that you pre-qualify yourself — ensuring you only apply where you have a good chance of getting the cash required.
Benefits of direct lending
- Debt financing — enables you to retain control of your business
- Flexible deal structures
- Tailored repayment plans
- Long-term loans offered
Limitations of direct lending
- Fees and charges — need to study the terms and conditions thoroughly
- May require collateral — like with a secured loan
- Usually not available for smaller loan amounts
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