Private Debt: Strategic Business Funding

Private debt, from the borrower's side, means taking a loan from a fund instead of a bank. For a mid-sized company that usually means a direct lender offering a single term loan to finance an acquisition, buy out a shareholder, or refinance bank debt. Direct lenders will often lend more than a bank, close faster, and hold the loan themselves rather than selling it on. They also charge more, write tighter prepayment terms, and in a downturn tend to amend loans in exchange for fees and a higher rate rather than write anything off.

This guide covers what a borrower should know before signing. Our private credit investing guide covers the same market from the fund investor's side, and our mezzanine financing guide covers junior debt that sits below a senior loan.

Who direct lenders lend to

Direct lending grew up around private equity. Most loans finance buyouts or add-on acquisitions by companies a private equity firm owns, and lenders look first at EBITDA, recurring revenue, and the sponsor behind the deal. The market has also been moving to larger borrowers: in Proskauer's annual review of its clients' 2025 US deals, 39% of loans went to companies with at least $50 million of EBITDA, up from 35% the year before (Proskauer).

Founder-owned companies without a sponsor can borrow from direct lenders too, particularly lenders that focus on the lower middle market, but they should expect less debt relative to earnings and closer monitoring. Smaller companies are usually better served elsewhere. SBA 7(a) loans go up to $5 million (SBA), banks remain the cheapest source for companies that fit their credit boxes, and asset-based lenders advance against receivables and inventory. Our small business loans guide covers those options.

What it costs in 2026

Valuation Research Corp. reported that unitranche spreads in the second quarter of 2026 generally ran from 4.75% to 5.50% over SOFR, about a quarter point wider than at the end of 2025, with loans issued at 98.75 to 99.25, meaning the borrower receives slightly less than the face amount (VRC). Smaller borrowers and sectors lenders are nervous about pay more. Software loans drew particular caution in 2026 amid concern about AI disruption.

An illustration with hypothetical numbers: a company with $12 million of EBITDA borrows $45 million (3.75 times EBITDA) at SOFR of 3.9% plus 5.25%, a 9.15% rate, issued at 99. It receives $44.55 million and pays about $4.12 million of interest a year. The effective annual cost depends on when the loan is repaid, because the discount and any prepayment fee are spread over fewer years:

A bank lending, say, 3.0 times EBITDA at SOFR plus 2.75% would charge about 6.65%, but on $36 million. The $9 million gap is often the reason a borrower goes to a direct lender. Measured at the margin, that extra $9 million adds about $1.72 million a year of interest, roughly 19% of the extra amount, because the whole loan moves to the higher rate.

Add legal fees on both sides, an annual agency fee if the loan has an agent, unused-line fees on any delayed-draw facility, and possibly the cost of an interest rate hedge if the lender requires one.

How much debt the business can carry

Middle-market deals averaged total debt of 3.9 times EBITDA in the second quarter of 2025, according to Prairie Capital Advisors (Prairie). For buyouts tracked by PitchBook, which skew larger, the median was 4.7 times in 2025, down from 5.2 times in 2021 (The Lead Left).

The more useful test is what happens when rates rise or earnings fall. Continuing the illustration:

Coverage of 1.88 times still pays the interest, but it leaves little for capital spending, taxes, and principal. Valuation Research Corp. found that in loans made in 2021, when rates were near zero, leverage had risen about 0.9 turns and cash interest coverage had fallen about 0.4 turns by early 2026. Those borrowers had sized their debt for low rates.

Covenants and reporting

Most middle-market direct loans carry at least one maintenance covenant, commonly a maximum ratio of total debt to EBITDA tested every quarter, sometimes with a minimum fixed charge coverage ratio. Covenant-lite loans exist but mostly for larger borrowers: 21% of the deals in Proskauer's 2025 data were covenant-lite, and 91% of those were for companies with more than $50 million of EBITDA.

If the illustrative loan has a maximum leverage covenant of 5.0 times, EBITDA can fall to $9.0 million, a 25% cushion, before the company breaches. What counts as EBITDA matters as much as the ratio. Negotiate the definition carefully: which one-time costs and projected cost savings can be added back, whether add-backs are capped, and whether acquired companies' earnings count from the start of the test period. An equity cure right, which lets the owners inject cash to fix a breach, is worth having and usually limited to a few uses over the life of the loan.

Expect monthly or quarterly financial statements, a compliance certificate each quarter, an annual budget, and audited annual accounts. Lenders monitor closely because they hold the loan to maturity; the reporting burden is part of the price.

Prepayment terms

Private lenders price loans expecting to earn interest for several years, so they charge for early repayment. According to Sidley Austin, the typical private credit structure is a 102/101 hard call: a 2% premium on amounts repaid in the first year and 1% in the second, applying to voluntary prepayments and some mandatory ones, often with carve-outs for a change of control or an IPO. Soft call protection, which applies only when you refinance to get a lower rate and usually lasts six to 12 months, is more common in syndicated loans and in larger, competitive private deals (Sidley).

Some loans start with a no-call period backed by a make-whole premium: the present value of the interest the lender would have earned through the end of that period, plus the first-year call premium. For the illustrative $45 million loan with a 12-month make-whole, repaying at month six would cost about $2.03 million of discounted interest plus a 2% premium of $0.9 million, about $2.9 million or 6.5% of the loan.

If a sale of the business in the next two or three years is realistic, the change-of-control carve-out is worth more than a small cut in the spread.

Unitranche, revolvers, and first-out/last-out

A unitranche loan replaces a senior loan plus a junior loan with one facility at one rate. Behind the scenes, lenders sometimes split it into a first-out piece with a lower return and a last-out piece with a higher one, documented in an agreement among lenders; BCRED's filings, for example, label some holdings as last-out portions of loans (BCRED 10-Q). For the borrower, it means one set of documents and one lender group to negotiate with, but in a restructuring the lenders' private arrangement shapes who calls the shots.

Direct lenders often provide a revolving credit line too, or share the security with a bank that does. A delayed-draw term loan can fund acquisitions after closing, with a fee on the undrawn amount.

When the business struggles

Default statistics for private credit vary with the definition. Proskauer's index of senior and unitranche loans showed a 2.51% default rate in the second quarter of 2026, down from 2.73% in the first (Proskauer). Fitch, which counts interest deferrals, payment-in-kind switches, and maturity extensions made under stress, reported a record 6.3% trailing rate in August 2026 (Epoch Times, citing Fitch).

That gap describes how private lenders handle trouble. With one lender or a small group holding the loan, a borrower that trips a covenant can usually negotiate an amendment quickly, which is easier than dealing with the hundreds of holders of a syndicated loan. The price is typically an amendment fee, a higher spread, tighter terms, and often more equity from the owners. Switching part of the interest to payment in kind preserves cash but grows the debt: paying 3 points of the illustrative 9.15% rate in kind for two years, compounding quarterly, adds about $2.8 million to the $45 million balance. If amendments stop working, lenders can take control of the company through the security package. Our distressed debt guide covers how those restructurings play out.

Comparing the main options

For broader context on business borrowing, see our guide to business debt strategy.

Preparing for a direct lending process

1. Commission a quality of earnings report so the EBITDA you present survives the lender's diligence; our M&A due diligence guide explains what it covers.
2. Build a debt model with SOFR one to two points higher and EBITDA 20% to 30% lower, and check coverage and covenant headroom in each case.
3. Talk to several lenders, including at least one bank, so you can compare terms rather than just rates.
4. Negotiate the EBITDA definition, covenant levels, cure rights, and call protection carve-outs with the same attention as the spread.
5. Hire counsel experienced in private credit documents; a financial adviser can run the process and benchmark terms.
6. Once closed, set up the monthly reporting and covenant calculations before the first test date.

This guide is general information, not legal, tax, or financial advice. Loan terms vary widely by lender, sector, and borrower. Figures in the illustrations are hypothetical, and market data is as of the dates shown. Consult qualified advisers before borrowing.