Why pursue direct lending in the core middle market?

Why pursue direct lending in the core middle market?
Key takeaways

The core middle market presents a large and fragmented opportunity set and attractive competitive dynamics vs. the upper middle market


Potential total return advantages include high current income relative to liquid markets with lower volatility


Sourcing and due diligence expertise is essential for success in this space due to the idiosyncratic nature of investment opportunities, while ESG experience can also differentiate lenders

What is the core middle market?

We define the core middle market as companies with between $100 million–$750 million in enterprise value and generating annual revenues between $10 million−$1 billion. The universe of companies in this segment is highly fragmented and represents a wide range of sectors and industries.

Relative to the lower middle market, companies in the core middle market have more robust infrastructure and governance and therefore tend to be less exposed to negative idiosyncratic events. Relative to the upper middle market, the core middle market is more fragmented and features a friendlier competitive environment.

Segmenting the direct lending market


Lower middle market

Core middle market

Upper middle market

Company enterprise value

< $100 million

$100 million–$750 million

$750 million–$3.0 billion

Company debt facility

< $50 million

$50 million–$400 million

$400 million–$1.5 billion

Company exposure to negative idiosyncratic risks




Company infrastructure and governance




Competitive landscape for deals

Highly fragmented

Strategy specific


Less competitive due to club transaction focus

More concentrated

Highly competitive

AUM growth focus


Small BDCs, small loan managers, and junior capital providers

Stand-alone credit platforms and medium-sized BDCs

Largest diversified credit platforms, regional/investment banks, large BDCs, and CLOs

Market landscape

Large, fragmented market with attractive characteristics

The U.S. middle market is a large and diverse ecosystem that represents virtually every industry, including business services, industrials, healthcare, consumer, and financial services.

Sector diversity of direct lending²

Source: Table statistics sourced from the National Center for the Middle Market as of December 2022. 2Sector diversification sourced from Cliffwater 2022 Q3 Report on U.S. Direct Lending.

The U.S. middle market at a glance1

  • 200,000 U.S. middle market companies
  • 33% of U.S. private sector GDP
  • ~48 million employees


Potential structural advantages of middle market senior secured loans

Middle market senior secured loans offer structural advantages that have the potential to meaningfully mitigate downside risk.

  • Senior position in the capital structure: Middle market senior secured loans sit atop the capital structure and are secured against substantially all of the assets of the company.
  • Terms: As bespoke arrangements created by a small group of lenders, terms are generally more favorable relative to the upper middle market—perhaps most importantly in the ability to include covenants which provide the lender an ability to proactively engage with the borrower should circumstances of the company change.
  • Inflation hedge: Middle market loans are floating rate instruments that can help to hedge against inflationary risk
  • Attractive spreads: To compensate investors for the market’s illiquidity and inefficiency, the direct lending asset class generally provides a yield premium relative to more liquid debt offerings

Prepayment protection: Middle market loans often provide mechanisms such as call protection to compensate lenders for prepayment, limiting reinvestment risk.

Comparing lending terms in the core vs. upper middle market

Terms in the core middle market are generally more attractive relative to the upper middle market, which is a more competitive space due to the larger size of deals and availability of traditional capital financing for many deals. For example, maintenance covenants continue to persist in the core middle market while there has been erosion in the ability to obtain meaningful maintenance covenants in the upper middle market.

Why are these covenants significant? They can help lenders:

  • Proactively address problems early
  • Limit cash leakage
  • Preserve collateral value
  • Force deleveraging when necessary

Key ingredients for success in middle market direct lending

We believe success in middle market direct lending requires two core areas of expertise: sourcing and due diligence.

Sourcing capabilities

The core middle market is extremely relationship-driven. Origination in the middle market requires strong connectivity and direct relationships with a broad base of private equity sponsors, networks of advisors, service providers, and management teams. Sponsors continuously seek to receive financing from lending professionals and platforms with whom they have had extensive experience—relationships driven by longevity, reputation, and trust. Credit platforms that offer borrowers a range of capital sources and are staffed with professionals who maintain close relationships with sponsors and issuers are particularly well-positioned.

Due diligence expertise

Middle market underwriting requires bottom up, fundamental diligence to comprehensively evaluate the health of the borrower. Unlike traditional debt strategies, middle market loan portfolios tend to be comprised of illiquid positions, meaning that a lender is likely to maintain an investment until repayment. A comprehensive evaluation of the issuer is needed to understand the sustainability of the business model and any potential issues that could impact the borrower’s ability to service its debt obligations. Sector knowledge is required to review an issuer’s performance, risks, and sector-specific concerns. Private credit platforms that possess sector-specific expertise and extensive industry relationships tend to be favored by deal sponsors as they can effectively and efficiently underwrite transactions.

Direct Lending

Our Direct Lending team has decades of experience in sourcing, underwriting, and executing senior secured loans in the core middle market. Our capabilities have made us a trusted partner in the space.

Learn more


  • 1

    Source: National Center for the Middle Market, as of December 2022.

  • 2

    Source: Cliffwater 2022 Q3 Report on U.S. Direct Lending