Why company size matters in direct lending

The private credit market has grown significantly in recent years as borrowers have found sourcing capital from private lenders increasingly attractive and as investors search for higher income. Direct lending, through which companies borrow from a smaller group of lenders without a bank intermediary, now represents the largest portion (44%) of the $2.1trillion private creditmarket.¹

Not all direct lending is created equal, however. The size of the borrower may significantly impact the potential risk and ultimate returns for end investors, with smaller borrowers more vulnerable to default in economic slowdowns. By contrast, larger corporate borrowers—often defined as those with earnings before interest, tax, depreciation, and amortization (EBITDA) in excess of $50million—have advantageous features that better position them to avoid financial stress and retain their value for lenders in challengingenvironments.

Larger borrowers have also benefited in recent years from the growth of private markets, which are now robust enough to provide complete, scaled solutions to larger borrowers. These solutions offer borrowers several benefits, including greater customization of loan structures, certainty of execution and terms, direct partnership with lenders, and access to financing through volatile markets.

Typical features of larger borrowers

Several features may better position larger companies to service debt obligations through challenging market environments and better protect the investments made by lenders. Theseadvantages include:

We believe these advantages combine to better position larger companies to service debt and enhance their value for lenders. Over the next few pages, we review several metrics—including higher EBITDA margins, stronger EBITDA resilience, and lower default histories—that evidence the relative strength of larger companies.
 

Higher EBITDA margins

Recent data points for private debt issuance show that larger companies consistently have higher EBITDA margins compared with smaller companies.2 As demonstrated in Figure 1, EBITDA margins for larger companies have been 1.2x to 1.6x higher than smaller companies that generate less than $50million in EBITDA annually. Businesses with higher EBITDA margins generally have more efficient cost structures and are more cash generative. As a result, we believe these companies are better able to service debt and are likely to benefit from greater financial stability and the ability to withstand potential economic headwinds.

_{Fig. 1: EBITDA Margin³
1Q 2019 – 3Q 2024}

For a longer historical perspective across a broader range of companies, considering the financial performance of equity index constituents is helpful. In the following analysis, Larger Public Companies reflects constituents of the Russell Midcap Index which have a median EBITDA of approximately $150million.4 Smaller Public Companies reflects companies in the Russell Microcap Index which have a median EBITDA of approximately $25million per year.5 Figure2 shows that larger companies have generated consistently higher margins compared with smaller companies. Between 2006 and 4Q 2024 margins for larger public companies averaged 14.7% vs. 5.0% for smaller public companies. These stronger margins we believe are evidence for superior market shares, more control over supply chains, better pricing power, and economies of scale for larger companies. Larger company margins have also been more stable over time, including through periods of market turbulence.

_{Fig. 2: EBITDA Margin⁶
1Q 2006 – 4Q 2024}

Stronger EBITDA resilience

Larger companies are typically better positioned to withstand challenging economic and market conditions. In each of the four key periods of economic dislocation over the past two decades, the EBITDA declines of smaller companies have significantly exceeded those of larger companies (Figure 3) in the same equity indices referenced above. The cash flows of smaller companies were hit particularly hard during the energy dislocation in 2014 to 2015 and the COVID-19 pandemic. With quarterly EBITDA declines greater than 100% during these two economic shocks, smaller companies went cash flow negative compared with larger companies which remained cash flow positive across dislocations, illustrated by an EBITDA decline of less than 100%. This strongly indicates there is generally lower potential downside from lending to larger companies.

_{Fig. 3: EBITDA Performance During Downturns⁶
Largest % Quarterly EBITDA Decline⁷}

Lower loan default rates

Default losses are usually a significant driver of return and differentiation to investors in private credit and avoidance of credit losses is an essential objective of all lenders. Since 1995 data suggests that larger companies have enjoyed a meaningful advantage versus smaller companies and produced meaningfully lower defaults. Figure 4 shows that through multiple credit cycles borrowers with greater than $100 MM in EBITDA had a 30% lower default rate compared with smaller borrowers between 1995 and 4Q 2024. We believe these long-term results demonstrate that larger companies have better navigated through market cycles than smaller companies and better protected lenders.

_{Fig. 4: Loan Defaults by Borrower Size^{8, 9}
(1Q95 – 4Q24)}

Lower private loan default rates

As private credit continues to mature as an asset class, better and more granular default data for private financings is now available. In private credit, larger borrowers also consistently have demonstrated lower default rates post-pandemic as interest rates and inflation rose (Figure 5). Since 2020, including the onset of the COVID-19 pandemic and ensuing economic and market volatility, default rates for larger borrowers averaged 25% less than defaults for borrowers with less than $25 MM in EBITDA. We believe these lower default rates for larger borrowers are indicative of the better credit risks these companies represent and, consequently, also indicative of the better investment opportunity available to investors in private credit.

_{Fig. 5:Private Credit Defaults by Borrower Size^{10, 11}
(1Q20 – 4Q24)}

Conclusion

Investing in direct lending that focuses on larger companies could be advantageous compared to smaller companies. Historical performance across multiple credit cycles suggests that larger companies would be less susceptible to default through challenging market environments driven by stronger and more resilient cash flow profiles compared to smaller companies.

_{Past performance is not indicative of future results. Please refer to the Appendix for additional endnotes.}