Private equity dealmaking has seen ups and downs throughout the year but certain firms are sensing that direct lending in the middle market is poised for opportunity. All told, as we report in the latest issue of Mergers & Acquisitions, direct lenders remain cautious but optimistic. Here’s a snapshot of what we’re seeing.

Direct lending to private equity-backed middle market firms saw record deal flow and capital deployment in 2021 and were on a similar pace in the first half of 2022. Lenders are aware of the market risk and impending recession but that is not stopping them from finding opportunities.

Direct lenders such as WhiteHorse Capital and Stellus Capital Management are seeing robust deal flow. Despite inflationary pressures and interest rate hikes causing the markets to contract, middle-market firms continue to seek capital for growth.

“Surprisingly, we’re still seeing private equity firms being pretty aggressive in looking at companies,” says Dean D’Angelo, founding partner of Stellus. “We’re seeing a lot of activity in private equity sponsors still willing to pay these multiples for good companies.”

Aside from macroeconomic factors, lenders are also making the most of inherent advantages that exist within the market. Chiefly, lenders are taking advantage of the absence of competition in lending from regulated banks. While banks have not entirely exited the middle-market lending space, Dodd-Frank capital requirements have them focused on low leverage cashflow-based loans or revolving credit facilities and asset-based loans.

Larger lenders to the middle market are moving up to target $2 billion or $3 billion deals which have created more opportunities for those lenders focused only on the middle market. In comparison to the last 12 to 18 months, lenders that used to target deals in the $50 million range are focused now on firms in the $200 million or higher range.

Where do you think direct lending is heading as we head into 2023? Let me know at [email protected]

Cole Lipsky