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like the underlying industry itself, the software debt markets have changed a lot in the past 5-10 years
10 years ago getting a meaningful amount of debt for a software company was a challenge. now leverage can be measured on ARR, not cash flow
10 years ago getting a meaningful amount of debt for a software company was a challenge. now leverage can be measured on ARR, not cash flow
in the earlier days of software lending (2005-2015ish), lenders lent to software PE on EBITDA
this is no longer always the case because venture-backed businesses (which PE is more frequently buying now) often have negative or breakeven cash flows
this is no longer always the case because venture-backed businesses (which PE is more frequently buying now) often have negative or breakeven cash flows
ARR loans started on the premise that they were just like ABL loans secured to AR, which are a standard product for most lenders
leverage multiples started in the 0.5-1.0x ARR range on this thesis
leverage multiples started in the 0.5-1.0x ARR range on this thesis
the original thought was:
a stream of recurring revenues with a predictable renewal rate was just as good as receivables because you could strip out the growth costs and pay off the loan with the ensuing "harvest case" cash flows
a stream of recurring revenues with a predictable renewal rate was just as good as receivables because you could strip out the growth costs and pay off the loan with the ensuing "harvest case" cash flows
If I loan you 1x ARR worth of debt, the business is flat, and you cut back to 25% margins, I get paid back in 4 years
or you should be able to sell the business for a pedestrian 1-2x ARR and I either barely get paid back or have a 50% margin of safety
or you should be able to sell the business for a pedestrian 1-2x ARR and I either barely get paid back or have a 50% margin of safety
lenders more recently have stretched leverage by underwriting higher growth businesses and focusing more on LTV (loan-to-value)
leverage multiples that started at 0.5-1x now look more like 2-3x ARR. if a business is growing quickly, "deleveraging" occurs naturally over time
leverage multiples that started at 0.5-1x now look more like 2-3x ARR. if a business is growing quickly, "deleveraging" occurs naturally over time
LTV is justified based on the enterprise value of the company, which is often tied to a discount to public comps
i.e. if the business gets sold for 5x ARR and I have senior secured debt up to 2.5x, the business could lose half its value, not grow, and I still get paid back
i.e. if the business gets sold for 5x ARR and I have senior secured debt up to 2.5x, the business could lose half its value, not grow, and I still get paid back
as a result, the private debt markets for software are even more sensitive to public market sentiment now than ever before
if there's a contraction or the momentum continues, it will ripple into private lending and PE as a result, like it did for a short time at the end of March
if there's a contraction or the momentum continues, it will ripple into private lending and PE as a result, like it did for a short time at the end of March
software is one of the better sectors to lend to for a number of reasons (particularly right now), so I doubt a multiple correction would cause long-term principal impairment, but it could cause some skittishness in the private capital markets
similarly, if the current momentum continues, we could see leverage stretch even further for higher growth companies
if you're growing 30%, will you be able to get a loan at 4-5x ARR in two or three years?
I guess we'll see
if you're growing 30%, will you be able to get a loan at 4-5x ARR in two or three years?
I guess we'll see
