Direct lending to lower-mid-market businesses has grown sharply over the past decade as banks retreated from this segment. Many of the businesses now borrowing from credit funds are owner-managed, founder-led, or sitting inside a small PE portfolio, and they are encountering formal credit diligence processes for the first time. The expectations differ materially from a bank relationship, and many borrowers underestimate how much preparation the process demands.
What credit diligence is actually checking
A direct lender conducting diligence on a sub-£50m deal is not simply reviewing whether the business is profitable. The review typically covers five distinct areas: the quality and sustainability of earnings, the reliability of the cash conversion cycle, the robustness of the management team's financial controls, the structure of existing debt and any intercreditor considerations, and the legal and covenant position of any security being offered. Each area carries its own documentation requirement, and the threshold for what is considered adequate is higher than most SME owners expect.
Earnings quality sits at the centre of the exercise. Lenders do not take reported EBITDA at face value. They want to understand the adjustments that sit between reported profit and the number being used to size the facility. One-off costs, restructuring charges, related-party transactions, and non-cash items all attract scrutiny. In lower-mid-market businesses, where accounting is often prepared for tax efficiency rather than management information, this normalisation exercise can produce results that differ significantly from the headline figure.
Cash conversion and working capital
A business can show strong EBITDA and still have poor cash conversion if working capital is poorly managed. Lenders look carefully at debtor days, creditor days, and stock turns, and they compare these against sector norms. Where collection periods are long or have been lengthening, they want to understand why. In businesses with concentration risk, where a small number of customers account for a large share of revenue, the credit position of those customers becomes part of the diligence exercise rather than just a commercial observation.
For seasonal businesses or those with lumpy revenue recognition, the analysis goes further. A lender sizing a revolving credit facility needs to understand the peaks and troughs in working capital demand across the year, not just the average. Businesses that cannot produce a reliable monthly cash flow history, or that have not modelled their working capital cycle in detail, tend to face more questions and longer timelines in credit committee.
What lenders expect from management
The management presentation is not a formality. Direct lenders at this level are making an underwriting decision without the benefit of a listed company's continuous disclosure obligations, and they are relying heavily on their read of the management team's financial discipline. They want to see that the business has a functioning finance function, that monthly management accounts are prepared on a consistent basis, and that the board receives timely and accurate financial information.
In many owner-managed businesses, the finance function is lean and the owner plays a central role in financial decision-making. This is not automatically a problem, but it raises a key-person question that lenders will probe. A business where financial knowledge sits entirely with one individual presents a risk that a well-prepared borrower should address before it surfaces in committee.
Common mistakes borrowers make
The most frequent errors we see are not complicated. Borrowers present adjusted EBITDA figures without adequate supporting workings, making it difficult for the lender to verify the adjustments independently. Historical accounts are produced in formats that do not align with the management accounts, creating reconciliation questions that slow the process. Contracts with key customers or suppliers that contain change-of-control provisions are identified late, after heads of terms have been agreed, rather than being surfaced and addressed in advance.
A second category of error relates to the security package. Borrowers sometimes assume that because a lender holds a debenture over the business, the diligence on the specific security being offered is less intensive. It is not. Where property, plant, or intellectual property is being offered as additional security, lenders will commission independent valuations and legal title reviews. Where these have not been obtained before the process starts, the timeline extends accordingly.
How to prepare before the process starts
Preparation is the part most borrowers underinvest in. A well-prepared information memorandum, supported by three years of audited or independently reviewed accounts, a current management accounts pack, and a properly evidenced set of EBITDA adjustments, allows credit committee to move faster and reduces the volume of follow-up requests. For businesses that have not been through an institutional lending process before, commissioning an independent financial review before approaching lenders can identify and resolve issues that would otherwise surface mid-diligence.
Equally important is knowing what the facility will be used for and being able to demonstrate that clearly. A lender making a decision about a growth capex facility needs to see the investment case for that capex, including how it feeds through into future earnings and what the repayment trajectory looks like. A lender refinancing existing bank debt needs to understand why the bank relationship is changing and what has been agreed regarding the transition.
The lender's position on covenant structure
Lower-mid-market direct lending deals are almost always covenant-based, meaning the facility carries financial maintenance covenants that are tested quarterly or semi-annually. Borrowers who have only dealt with bank overdrafts or invoice finance facilities sometimes enter these agreements without fully understanding that a breach of covenant is a technical default, even if the business is trading profitably and servicing interest without difficulty.
Understanding covenant headroom at signing, and stress-testing it against a realistic downside, is something a borrower should do before signing rather than after. What happens if revenue misses budget by fifteen per cent in year one is not a hypothetical; it should be answered at term sheet stage so that the facility includes appropriate cure provisions from the outset.
If you are preparing for a direct lending process or reviewing the terms of a proposed credit facility, Blash Advisory works with borrowers and their advisers on the diligence preparation and financial analysis that make these processes faster and better-informed. To discuss your transaction, book a consultation.
