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The private debt market has undergone significant transformation over the past decade, with direct lending rapidly emerging as the dominant financing option for middle-market companies. Traditionally, mezzanine debt played a key role in funding leveraged buyouts (LBOs), recapitalizations, and growth initiatives. However, direct lending has steadily gained traction, surpassing mezzanine debt as the preferred source of financing. This shift has been driven by several factors, including changing risk appetites, evolving market conditions, and the competitive advantages that direct lenders offer over mezzanine providers. In this blog, we delve into some of the key advantages of direct lending over mezzanine debt and explore just a few of the many AI-powered features in AXIS that can help automate and optimize the direct lending process!

The Rise of Direct Lending

Direct lending refers to non-bank lenders—typically private debt funds—providing loans directly to businesses without intermediaries such as investment banks. These loans, often structured as senior secured credit, offer more attractive terms for both borrowers and investors compared to mezzanine financing. As institutional investors continue to allocate more capital to private credit, direct lending has expanded rapidly, surpassing mezzanine debt in both volume and importance.

Key Advantages of Direct Lending Over Mezzanine Debt

The shift in preference from mezzanine debt to direct lending is not just a matter of cost; direct lending offers several structural and strategic advantages.

1. Lower Cost of Borrowing

Direct lending funds primarily issue senior secured loans, which carry lower interest rates than mezzanine debt. With increased competition among direct lenders, interest rate spreads have compressed, making direct lending an attractive option for borrowers looking to optimize their capital structures. This cost efficiency allows companies to allocate more resources toward growth and operational improvements rather than excessive debt servicing.

While borrowers enjoy the lower cost of borrowing that comes with direct lending, lenders are also always seeking ways to lower their operational costs. With AXIS by AIO Logic, they can do just that. Thanks to AXIS’s best-in-class architecture, lenders can cut costs by up to 50% at every stage of the loan lifecycle. AXIS’s automation can perform tasks, analyze data, and execute processes faster and more accurately than humans, leading to substantial efficiency gains and cost savings.

2. Stronger Collateral Protection

Mezzanine loans are unsecured or deeply subordinated, meaning they rank behind senior debt in repayment priority. Direct lending, on the other hand, typically involves first-lien or unitranche structures that provide lenders with priority claims on borrower assets. This lower risk profile makes direct lending more appealing to investors while offering borrowers more certainty in financing. Borrowers benefit from reduced overall leverage risk, making their financial positions more stable in times of economic downturns.

The importance of structuring repayment priorities cannot be overstated, so we placed heavy emphasis on this when building AXIS. In AXIS, lenders can easily structure each new loan with as many tranches as needed, and set a repayment priority for each tranche. Additionally, once the repayment priority for a tranche has been set, lenders can define how much and at what date that tranche will be paid. These user-friendly customization options go a long way in protecting lenders while offering borrowers more certainty.

3. Faster Execution and Greater Flexibility

Direct lenders operate with greater speed and flexibility compared to traditional mezzanine providers. Their streamlined approval processes and ability to customize loan terms—such as covenant-light structures or tailored amortization schedules—give borrowers an advantage in competitive deal-making environments. This speed of execution is particularly beneficial for sponsors and businesses looking to close transactions swiftly without lengthy negotiations or syndication delays.

Thanks to the robust functionality and sophisticated automation of AXIS by AIO Logic, lenders can operate swiftly and with great flexibility. Due to its robust functionality, AXIS has native handling for every commercial loan structure including amortizing, revolving, interest only, delayed draw, and many others. This allows lenders to customize loan structure and terms to meet the needs of borrowers. Additionally, AXIS’s sophisticated automation allows lenders to automate complex workflows across a range of loan structures, leading to streamlined processes and faster execution.

4. Market Adaptability in Uncertain Times

In the current macroeconomic environment, characterized by changing interest rates and economic uncertainty, borrowers seek greater predictability in their financing structures. Direct lenders offer floating-rate debt, which better aligns with market conditions compared to fixed-rate mezzanine debt, making direct lending a more adaptable solution. This adaptability ensures that companies can respond more effectively to changes in interest rate environments and market fluctuations, enhancing financial resilience.

Another aspect of AXIS’s robust functionality is the wide range of interest rate structures supported by AXIS. To that end, AXIS provides independent functionality for Current and PIK interest, and simple and compounding interest. In addition to fixed rates, AXIS allows lenders to use variable rate structures. For variable rates, users choose the desired index, index calculation logic, and margin to be added to the index rate. Once set, AXIS automates the entire applicable rate calculation. This ability to customize interest rate structures allows lenders to better meet the needs of their borrowers, especially in uncertain times.

5. Higher Certainty of Execution

Direct lenders, particularly private debt funds, often have committed capital readily available, allowing them to execute deals with greater certainty compared to traditional mezzanine lenders, who may require syndication or multiple funding sources. This reliability makes direct lending an attractive choice for borrowers looking to secure financing without delays or last-minute changes. The ability to lock in capital quickly and with minimal conditional approvals enhances borrower confidence in executing strategic initiatives.

For borrowers, accessing funding in a timely manner is often vital. With that in mind, our AXIS platform can speed up the process in several ways. For example, AXIS’s AI can automate the initial screening and validation of loan applications, reducing the time and effort required for manual processing. Additionally, when it comes to credit scoring and risk assessment, AXIS can analyze a wide range of data points (e.g., financial statements transaction history, and market data) to assess the creditworthiness of borrowers, providing a quick and accurate underwriting process.

Conclusion

The rise of direct lending over mezzanine debt marks a fundamental shift in private debt markets. With its lower cost, superior collateral protection, faster execution, and increasing institutional support, direct lending has emerged as the preferred financing option for middle-market borrowers. As private equity firms and corporate borrowers continue to prioritize efficiency and flexibility, direct lending will likely remain the dominant force in private credit for the foreseeable future. If your firm is seeking to automate and optimize its direct lending operations, please feel free to contact us today to schedule an intro call and learn more about all that AXIS has to offer!