Once a niche alternative to traditional bank loans, direct lending has grown into a $1.5 trillion market that is expected to reach nearly $2 trillion by the end of the decade.

Growth has led to maturity and the emergence of distinct market segments across lower middle market (LMM), core middle market (CMM) and large cap (LC). Managers who can operate across all three segments will define the next phase of direct lending’s evolution.

THREE SEGMENTS, ONE CONTINUUM

Direct lending is best understood as a continuum spanning LMM, CMM and LC. Together these segments represent primarily nonbank, floating-rate term loans to single B-rated corporations across diverse industries. All three share defensive qualities: loans are generally in a first lien position with secondary sources of repayment, and have inflation-hedging characteristics from the floating rate nature of the loans.

Yet each segment demands unique competencies. In LMM, deals are often sponsor-backed, supporting buy-and-build strategies for companies with $5–25 million in EBITDA. These companies are resource-constrained, making disciplined underwriting and strong sponsor relationships essential. The competitive dynamics favor focused firms with deep expertise and credible workout capabilities. As direct lending has matured, many players have moved up-market, which leaves more favorable conditions for firms that remain committed to LMM.

CMM, encompassing companies with $25–75 million in EBITDA, is defined by the breadth of sourcing capability. While sponsor-backed deals remain active, the biggest opportunity lies in accessing the vast non-sponsored universe — companies not owned by private equity, often family- or founder-led, and traditionally bank-financed. Direct lenders with large origination networks and long-term relationships can generate deal flow away from auctions and PE-led processes. These transactions tend to mirror those typically proposed by regional banks with strong covenants, tight terms and modest leverage.

The LC segment, for companies with EBITDA above $75 million, emerged as an alternative to public syndicated loans and high yield markets. In this segment, managers must leverage scale and deep relationships with sponsors and advisors. They also need sector expertise, since fewer structural protections exist. The LC market today can provide enhanced execution, customization and speed, with illiquidity pricing premiums and structural enhancements that put it on equal footing with public markets.

THE POWER OF A BROAD PLATFORM

Historically, firms specialized and built deep expertise in one market segment, with some seeking to transfer that knowledge to the next segment.

Few firms have developed and tailored capabilities across all segments. But the potential benefits of taking an approach that encompasses the continuum of direct lending are striking:

• Dynamism: Allocating across LMM, CMM and LC reduces concentration risk and enables managers to pivot as market conditions shift.
  
  For instance, the LMM and LC segments have an orientation to buyout markets; the CMM segment less so. Accessing the continuum on a dynamic basis would allow investors to access LMM and LC segments when buyout markets are buoyant and pivot to CMM, with its emphasis on direct origination, when M&A activity is more muted.
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• Scalability and Yield Enhancement: Operating as a platform also allows managers to take a blended approach to scale and yield enhancement.
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  It is easier to deploy capital at scale in the LC segment, and it is relatively more liquid, allowing investors to quickly access the direct lending market. LMM and CMM are harder to access quickly but generate higher spreads as a function of being less liquid. For large institutional investors with significant deployment requirements, managers operating across the continuum can combine scale and quick deployment through the LC segment with yield enhancement from LMM and CMM.
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• Origination Advantage: Exposure to all three market segments allows investors to access a diversified pipeline of deal flow across sponsored and non-sponsored channels. Drawing on both creates diversification potential by combining highly disciplined underwriting with a steady, deliberate investment pace.
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• Flexibility: As borrowers grow or undertake corporate activities like spin-offs, they move across segments. Some LMM borrowers eventually migrate to LC, while LC names may spin off units that become LMM or CMM credits. When managers treat direct lending as a continuum, they can follow companies through their lifecycle and apply credit insights and relationships built over decades.
  
  Those insights ultimately help evaluate credit risk. But the relationships also ensure that manager and borrower are connected and able to act quickly and with conviction when a financing need arises.
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• Selectivity: Operating across the spectrum of direct lending segments gives managers a large pool of transactions from which to source the most attractive investment opportunities. The range of opportunities can be greatly increased significantly if managers are also able to source transactions from both sponsored and non-sponsored channels (over 90% of the 200,000 middle market companies in Europe are non-sponsored, for instance).

THE STRATEGIC IMPERATIVE

Building investment capabilities across all segments is challenging — and it’s becoming even more so.

Few managers can combine deep credit research, origination networks and strong sponsor relationships. Still fewer can present these capabilities as a unified platform that is able to dynamically allocate and nurture borrower relationships across the company lifecycle.

In a market where scale, flexibility and insight matter more than ever, we believe breadth is the ultimate edge.