Backing Britain’s backbone: the investment opportunity for UK asset owners in SME lending

The UK’s economic future depends not only on global capital markets or FTSE 100 multinationals, but on the strength, adaptability and innovation of the country’s small and medium-sized businesses. SMEs are the backbone of regional economies across the UK.

For local government pension schemes (LGPS) and other asset owners, investing in this segment through direct lending strategies offers an opportunity to support communities, strengthen regional economies, and deliver stable, attractive returns for scheme members.

Engine of the economy

According to the Office for National Statistics (ONS), there are around 38,000 medium-sized companies in the UK (defined as those with 50-249 employees), spread across sectors from healthcare and education to professional services and IT. These companies are significant employers and contributors to the economy, accounting for 3.7 million jobs and nearly £900bn in turnover.

Activity is not dominated by the South: the North of England accounts for 28% of employment and 34.5% of turnover, versus 25.6% and 35.4% for London and the South East. What makes this segment particularly relevant to asset owners is its scale and regional distribution, aligning directly with their goals of supporting local economies.1

Filling the funding gap

Despite this, many of these businesses face persistent barriers to financing, especially outside London and the South East. According to the Department for Business and Trade, banks now reject around half of applications for business loans, down from 67% before the Covid-19 crisis.2

Meanwhile, many private debt managers focus exclusively on larger, or upper middle-market transactions, leaving a growing gap for companies with EBITDA between £5m and £25m, what we define as the lower-middle market.

In 2024, 70% of the total 157 UK private equity-sponsored debt financing transactions came via direct lending funds. Of these transactions, 40% were used for leveraged buyouts, 34% for bolt-on acquisitions and 26% for refinancings or recapitalisations.3

The importance of a local presence

At Muzinich & Co., we are positioned to support this underserved segment through tailored, long-term loans. We launched our UK private debt platform in 2015, and the UK typically accounts for approximately one-third of our pan-European deployment. We raised close to €1.6bn across our first two pan-European lower-middle market strategies and are targeting €1bn for our third. We believe an allocation to such a strategy can help schemes achieve their desired UK investment targets – regionally or diversified across the UK. It also offers an attractive return profile, benefitting from the diversification and scale provided by a pan-European offering.

With nearly 40 professionals across the UK and Europe – including teams in London, Manchester and other regional centres – our platform is embedded in local business ecosystems. Our Manchester office, for example, consistently generates around 40% of our UK deal introductions and we are the only lower-middle market private debt manager with offices in both Manchester and London.

In a market as relationship driven as the North, being physically present matters. Our local deal teams originate, execute and monitor transactions throughout the investment lifecycle: there is no separate portfolio team, unlike many banks. This continuity allows for responsive, long-term relationships with borrowers.

Tailored solutions for borrowers

Lower-middle market companies typically seek capital to grow, often through M&A, recapitalisations or strategic investments. These companies often fall outside the scope of rigid bank lending criteria. Private lenders like Muzinich can offer:

• A flexible, long-term partnership approach
• Investment across the capital structure, from senior debt to minority co-investments
• Bullet repayment structures tailored to company needs
• Higher funding capacity than banks, including for follow-on investments
• Streamlined decision-making with local autonomy
• Speed and certainty of execution

We believe such an approach can address the significant barriers many borrowers face in accessing finance, especially those in underserved regions.

The case for UK asset owners

For investors, committing to the UK lower-middle market offers a compelling alignment of return and economic objectives:

• Enhanced yield: our strategy has delivered an average net annualised cash yield of 7%+
• Stronger protections: conservative leverage and robust covenant packages
• Diversification: exposure across sectors like healthcare, professional services, manufacturing and technology
• Lower defaults: despite their size, well-structured lower-middle market loans historically show lower default rates than larger corporate debt
• Local economic impact: capital is deployed in the communities schemes represent, supporting jobs, innovation, and economic resilience

For asset owners, an allocation to UK middle market debt can support their investment goals and their commitment to sustainable economic development. By partnering with experienced direct lenders with a local presence, these investors can secure attractive risk-adjusted returns while supporting local businesses across the UK.

The key to success lies in selecting partners with proven regional commitment and expertise across economic cycles, including experience of managing through challenging situations. As traditional sources of capital continue to decline, the opportunity for asset owners to fill this financing gap while meeting their fiduciary responsibilities has never been more compelling.

Sources

1 All data in ‘Engine of the economy’: Department for Business and Trade, ‘Business population estimates for the UK and regions 2024: statistical release,’ October 3, 2024. Most recently available data.

2 Department for Business and Trade, ‘Small business access to finance,’ May 8, 2025

3 Houlihan Lokey, ‘MidCap Monitor Q4 2024,’ March 2025. Most recently available data.