Private credit is booming, but Europe’s mid-market companies are left hanging

By Gabriella Sahlman, co-founder and Managing Partner of Fuels Capital

Private credit is under the microscope after a series of high-profile bankruptcies – including auto parts manufacturer First Brands and subprime auto lender Tricolour – exposed poor lending standards in the industry. It prompted the European Central Bank to examine Europe’s exposure to similar failures, and the bank subsequently flagged weak underwriting and opacity in parts of the market as serious concerns.

But years of chronic underinvestment mean Europe depends on private credit. Mario Draghi’s landmark report on European competitiveness suggests the continent needs at least €750–800bn in additional investment every year to help finance its strategic priorities, including infrastructure, defence, startups, and energy security. And bank financing alone cannot close that funding gap.

Part of the problem is that private credit’s growth as an asset class does not directly translate into financing for European mid-market businesses. In other words, many companies that need capital, particularly smaller businesses and entrepreneur-led companies that form the backbone of the European economy, are least likely to get it. The European Commission puts the debt financing gap at €39bn per year.

That gap exists because private credit is not a single market. Instead, it covers a broad range of different strategies, borrowers and risk profiles. For example, a billion-euro loan to a large, PE-owned company from a global direct lending fund differs profoundly from a bespoke, asset-backed loan to an entrepreneur-led business in the Nordics or elsewhere in Europe. Both play an important role, but they serve different needs.

Yet despite the market’s diversity, private credit remains heavily concentrated in one type of borrower. According to media reports report, private equity-backed companies make up just 5–10% of investable companies in Europe, yet they absorb 89% of private credit.

This reflects the persistent problem whereby mainstream lenders tend to prioritise standardised corporate profiles, with stable earnings and conventional credit histories, over businesses that fall outside these models. Even when those companies hold valuable assets that offer credible investment opportunities, temporary cash-flow pressures can be enough to deter risk-averse investors from taking a closer look.

This is a growing problem. Our estimates at Fuels Capital suggest that around 25–30% of European mid-market companies do not currently qualify for any of the three mainstream financing channels: bank lending, direct lending or bond markets. Typically, these are companies undergoing acquisitions, ownership transitions, expansion, or refinancing. For them, the challenge is sourcing financing structured to fit their unique circumstances.

But expanding access to credit for these more “complex” companies – in other words, fundamentally sound businesses that face cash flow constraints for various reasons not necessarily indicative of weaknesses in the underlying business – cannot mean repeating the loose underwriting mistakes that put the industry under scrutiny in the first place.

The true quality of underwriting is revealed when things go wrong. Credit investing is easy when everything goes according to plan, but the real test comes when a business underperforms, markets change, or the original business plan fails to materialise – as First Brands and Tricolor have demonstrated. Only then do we learn whether the lender truly understood how the loan would be repaid, what the underlying assets were worth, and whether the security could actually be enforced. Security that exists only on paper offers little protection.

Credit is about structuring for uncertainty, not predicting the future. The aim should be to structure a loan so that you can be wrong. A flexible approach to collateral and loan structuring can unlock financing opportunities that conventional lending models may overlook, but only when combined with disciplined underwriting, a clear understanding of repayment sources, and robust downside protection. Where possible, collateral should provide a recovery source that does not depend wholly on the underlying business’s performance.

The answer is not to lend to every business that cannot get bank financing, since some businesses are simply too risky to finance. The opportunity lies in identifying those where underlying value and available security support a loan, even if they do not fit a conventional cash-flow lending model.

If Europe is to mobilise the investment needed to remain competitive, it needs more than a larger private credit market. It needs a more diverse one, with specialist lenders able to finance fundamentally sound businesses that fall outside conventional lending models.

The answer is not to weaken underwriting standards, but to look beyond standardised cash-flow metrics and structure loans around the value of the underlying assets, with robust protections if things go wrong. Europe needs more credit funds focused on specific niches, rather than more of the same.