You recently acted as lead arranger on a €87.5m first lien senior secured ARR financing for Kpler. Can you tell me about it?

We’ve been doing ARR financing for a number of years. It’s typically for companies with immature or negative EBITDA or cashflow, but a very visible and predominantly contracted revenue stream. This is typically a software business, or a business where the customer needs a clear service as part of their daily work flow. Kpler is a very strong business with a leading market position in an attractive niche, and we were very pleased together with Apax Credit to offer the ARR financing to support the founders and sponsors [Five Arrows Growth Capital and Insight Partners] in the company’s strong growth.

In terms of putting together an ARR financing, what we assess is broad. It will, however, include revenue retention and stability, otherwise known as ‘churn’. This is calculated as a percentage figure — 10% churn translates into the customers staying approximately ten years before leaving, 5% means 20-years. Net revenue retention tells you the percentage of revenue that is contracted after churn, as well as other changes, such as the upselling of other additional services. At 110% or 120% net revenue retention, you can be reassured that the company is growing very well on a contracted revenue basis whilst it grows its presence and matures into generating profit and cashflow.

Kpler had very strong metrics based on what we have seen in the market. So ARR-based financings are attractive when they demonstrate stable contracted revenue, often based on two to four years’ outlook. That stability is critical given the absence of positive cashflow in most cases.

What do terms look like on an ARR-based private credit financing?

Covenants are a feature in every deal. Some ARR deals are ARR for life, with a debt-to-ARR covenant, although we have seen this move more to a mandatory or occasionally optional conversion to EBITDA. For example, let’s say EBITDA reaches a pre-agreed figure, the leverage covenant then kicks in based on that profit level. There’s also always a liquidity covenant during the ARR covenant period and sometimes a company-specific covenant.

And pricing?

For pricing, you have to factor in the loan-to-value (LTV) of the business. On an ARR financing, the LTV is often quite low. It’s harder to borrow when you’re a company that burns through cash and has no profit. Plus the valuations of growth businesses, in which ARR financings would be classified, are often quite high relatively. An ARR-based financing would typically be on a business with an LTV of 10-35%, while a unitranche deal could be based on an underlying LTV of say 40-55%. So there’s a price premium for ARR financing of about 100-200 bps over an EBITDA financing.

How does the capital structure vary?

Given that your typical ARR-financed business is burning through cash, it can make sense to include a cash-pay element and a PIK element in the deal, let’s say a minimum cash pay of 5-6% and then PIK the rest. Of course, there would be a premium to pay for this kind of flexibility, maybe +850 bps with PIK, +750 bps without.

Where does an ARR-based financing sit in the portfolio of a ‘plain vanilla’ private credit fund?

That really comes down to the investors and the fund profile. In a fund structure with many LPs, then it’s down to your limits for different types of deal - how many ARR deals can you do? Some ARR deals can be really quite large. In a managed account with one investor, then it’s about what you agree with that investor and their own risk return profile. There’s a notable ARR financing of more than €1bn, for example, but they can range from €50m to €1bn.

Is it as clubbable as an EBITDA-based financing?

ARR deals do club. The €1bn deal I mentioned is a club with a few other lenders. I wouldn’t say from a technical perspective that it’s any more difficult to club than an EBITDA deal. One factor to consider though is that not every credit fund does ARR. In terms of banks, we have relationships with a number of banks that are happy to be in a deal with a private credit fund. Within that, there are a limited few banks that will do ARR.

Speaking of relationships, how does the deal sourcing work? Do you leverage off of a sponsor network?

ARR deal flow comes from our broader network. ARR deals can involve private equity or sometimes they are a sponsorless transaction. Why? A classic ARR transaction is a tech company with founders, and because of their position they are always interested in who’s in the equity and who their lender is. Founders are certainly self starting, and they call their friends, other companies, then they come to you. Companies suitable for ARR-based financing tend to cluster in certain geographies and certain hubs that have a supportive growth culture, so we’re mindful of that too. I’ll reiterate though that sponsorless transactions are still less than 10% of what we do.

And to those who call it venture debt?

There’s a fine line, but I would call it growth equity financing. Venture is early, growth is more mature. Put simply, you have seed, venture, growth, then LBO. An important question to ask is, could this company do the financing off of EBITDA or have EBITDA should they choose to grow less? If that’s possible, then I wouldn’t call it venture debt. Growth equity lending or late-stage venture lending is a more accurate description. You’re looking at growth but also at stability and maturity.

Lastly, we hear you’ve discovered padel. Please tell us more!

Padel is a mix between tennis and squash. It’s usually played in doubles on an enclosed court surrounded by walls of glass and metallic mesh. The court is one third of the size of a tennis court, and the ball can bounce off any wall but can only hit the turf once before being returned. In terms of scoring, it is the same as tennis. It’s a great, fun sport to play, with the advantage that you can hit the ball quite often - it has longer rallies than tennis. I play in Dublin and London (and anywhere else!), and it’s growing fast. In Sweden they have it in schools, but it’s not quite there yet in Ireland and in the UK.

He gets out his padel racket. It looks like a squash racket crossed with a colander.

It’s extremely lightweight to hold. You don’t need to be particularly fit to play padel tennis. The excitement for me is really about discovering a new sport. I also played for Ireland in a Six Nations competition last year in Finland, which was a lot of fun and a great way to meet people.