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    What is Direct Lending and How it Works

    By sbanderas | February 23 2021
    220

    If you’ve ever been strapped for cash and had to borrow money from a friend or family member, then you are, in a way, already familiar with direct lending and how it works. In its essence, direct lending is the process of borrowing money, but cutting out the middleman – in this case, it would be the bank. In the wake of the 2008 global meltdown, tougher regulations were put into place, curtailing the banks’ ability to lend money to individuals and especially younger businesses. In this vacuum alternative methods of lending emerged, and the one that has gained considerable traction these days is direct lending. 

    If you are concerned about possible running out of cash during these tough times and are considering weighing your options, this rough guide to direct lending should help.

    Who Can Use Direct Lending?

    Direct lending is the practice of offering credit primarily to smaller or mid-sized businesses in order to help them with growth, establish sustainability practices, and landing acquisitions. Since bigger banks have curtailed their supply of loans, new asset-backed providers such as direct lenders have come in to fill the gap. Direct lending has become the domain of private institutional lenders who are not always as curtailed in their lending ventures as more mainstream banks are, meaning they offer a lifeline to smaller businesses who are unable to find any other outlet. 

    Since direct lenders have a bit more flexibility than what banks can offer, they tend to have investments from pension funds and insurance companies, which enable them to invest in the business’ long-term future. So, they are not just there if your business requires a quick fix, but can actually help for whichever business goal you have in mind. As a funding option, they are incredibly useful because they help meet companies where they are, as opposed to imposing different rules on them that will make it harder for business owners to pay off the debt.

    How Do They Work?

    The next question you may have in mind is trying to square away how these loans work. Basically, when you apply for payday loans, the asset manager at the direct lending enterprise will help raise capital from different investment sources before making an offer to you as the potential borrower. Since there is considerable flexibility involved, there are different tiers of funding that can be offered.

     

    The first is the most straightforward: you will apply for a certain amount, and sign off a contract by which you promise to repay the debt within a certain timeframe, making an x number of installments. The second tier is a debt that will be repaid but after what is called a senior lien. This is a kind of security interest that is placed on a property, and which will be used to pay off the debt. 

    The third and final form of funding typically offered by direct lending consists of a hybrid loan structure that combines both junior and senior debt into one blended interest rate of repayment. This kind of structure is typically referred to as unitranche debt, and its structure is often preferred since it increases the flexibility of direct lending options, providing companies with increased access to capital.

    Careful Monitoring

    While direct lending became a force in the financial world in the aftermath of one of the world’s most terrifying financial meltdowns, it is not a passing fad, and it is definitely here to stay. At first, a few direct lenders gave it a bad name, and payday loans have become synonymous with hucksters robbing the poor blind. Of course, such financiers are not legitimate and there have been crackdowns on these kinds of predatory loans. That being said, you should still be on the lookout and go to reputable lenders who know what they’re doing and have your best interest at heart. 

    Also, keep in mind that the boon offered by direct lending is sometimes exactly what works against it. Some borrowers may not be comfortable with the fact that a single lender can have more power in negotiations or board meetings, so this is something to consider. Also, if you manage to earn more money, then you may find yourself staring down the business end of more tight credit regulations and downgrades. So, be sure to read the fine print and ask any questions you may have from the get-go.

    There are quite a few upsides to direct lending, and it is definitely here to stay. However, you should also expect that it will change over time, and become more receptive to the changing demands of its users. The financial landscape is currently being transformed by the Covid-19 crisis, and it only makes sense for other lending options to respond in kind. In any case, if you are the owner of a small company that needs an extra boost of investment to get to where it needs to be, then direct lending is certainly a viable option to consider.