What Is Direct Lending? Definition, How It Works and Examples

The Federal Reserve describes it this way. When one lender and one borrower originate a loan between themselves, the loan is often called direct lending. A small group of lenders can do the same. Brookfield, an asset manager, defines it as a loan from non-bank creditors to a business without an intermediary. It is a part of private credit, the wider market of lending outside banks and public bonds.

The typical borrower is a middle-market company, meaning a mid-sized business. The Fed puts such firms at annual revenues between $10 million and $1 billion. For a majority of these loans, a private equity sponsor backs the borrower. A sponsor is a firm that owns the company and often borrows to buy it. The lender negotiates terms directly. It checks the company, sets the price and keeps the loan on its own books. Bain & Company says private credit remains the lender of choice for deals under $1 billion.

Almost all of these loans carry a floating rate. The rate is a base rate that moves with the market plus a fixed margin, called the spread. The interest payment rises when market rates rise and falls when they fall.

In older banking use, “direct lending” can mean a bank lending straight to the customer, for example for a car loan, without a dealer in between. This page uses the investment meaning. There the lender is not a bank. Banks still matter in the story. The IMF notes that banks appear to have become less willing to lend to mid-sized firms. The Fed adds that tighter bank rules could move even more lending to private lenders.

A senior loan is repaid first. It is usually secured, which means the borrower pledges its assets and the lender can claim them if the loan is not repaid. The Fed says direct lending funds’ loans are typically senior secured. Brookfield says the term most commonly means first-lien loans, the first claim on the pledged assets. Other lenders take a junior place behind them and charge more.

Here is how the order works in a failure. Suppose a company owes $40 million on a senior loan and $20 million on a junior loan. Its assets sell for $45 million. The senior lender is repaid in full. The junior lender gets $5 million. Shareholders get nothing. The same priority is why shares, which sit last in line, are riskier than the loans.

A fund lends $40 million to a software company owned by a sponsor. The rate is a base rate plus a 5.5% spread. The fund also charges a 2% fee when the loan closes. The table shows the first year under three base rates.

The same floating rate also raises the borrower’s costs. When the base rate climbs from 4.0% to 5.0%, the company pays $0.4 million more in interest each year. That is why the lender watches the borrower’s cash flow. The Fed notes that borrowers in this market have low collateralizable assets and high leverage, meaning a lot of debt compared with what they own. It also notes that recent deals are devoid of financial maintenance covenants, the tests that once let a lender step in early.

A direct lending fund pools money from investors and lends it to companies. Investors usually take a share of the interest, after fees. Funds come in a few forms. A private fund takes commitments from qualified investors and holds the loans for years. A business development company (BDC) is a regulated company that must keep at least 70% of its assets in qualifying investments such as loans to US private companies. An interval fund offers to buy back 5% to 25% of its shares at set dates, every three, six or twelve months. A buyback is not a promise to sell, and requests above the limit are cut back.

Common Mistakes

• Treating a private loan like a bank depositA loan can lose value if the borrower fails. These loans have no deposit insurance.
• Assuming senior means safeSenior loans rank first, but a failing borrower can still repay less than the full amount.
• Forgetting that most loans are floatingA drop in market rates lowers the lender’s income. A rise lifts the borrower’s cost.
• Expecting to sell a loan any dayPrivate loans have no exchange. Funds that promise regular buybacks can limit them.
• Mixing up market sizesThe Fed counts about $800B of direct lending and the IMF counts $2.1T for all private credit. They cover different scopes and dates.

Direct lending

A loan made straight from a non-bank lender, usually a fund, to a company on negotiated terms.

Private credit

Lending to companies by non-bank lenders, outside public bond markets.

Floating rate

An interest rate made of a base rate that moves with the market plus a fixed spread.

Senior loan

A loan repaid ahead of junior debt and shares, usually secured on the borrower’s assets.

Middle-market company

A mid-sized business, too small for bond markets and often owned by a private equity sponsor.

Business development company

A regulated company that must keep at least 70% of its assets in qualifying investments, mainly US private companies.

Covenant

A condition written into a loan, such as a limit on the borrower’s debt.

Figures were last checked on October 13, 2026. They describe the United States unless stated. The loan example is invented.