Private credit loans generally have seven-year tenors, but they typically sit in the portfolio for only two or three years before the borrower is sold (triggering a redemption, unless the debt is portable) or the debt is refinanced at a lower rate cost and a new set of lenders are brought in. 

It’s the unfortunate consequence of success: the growth has materialized, the EBITDA add-backs have been proven, and the projected synergies have been achieved.

Theoretically, most companies begin their borrowing journey in the middle-market space, with private credit lenders or small regional banks. In time, they can graduate to the broadly syndicated loan market, where capital is more plentiful and borrowing costs are lower. It’s the bank and non-bank markets working together harmoniously.

In recent months, that process has been jammed up for a multitude of reasons. Sponsor-to-sponsor sales have been in a slump for a while, with sellers (many of whom bought at the peak of the market in 2021) struggling to agree on valuation with bidders who now expect to pay less. The other standard exit strategy — the IPO market — remains seriously depressed.

via EY and Dealogic

Growing, growing, gone

There is a third way for sponsors: selling to strategic buyers. And two recent examples suggest that it’s an increasingly viable option. 

This week, IBM announced an agreement to acquire financial software company Apptio for the princely sum of $4.6bn. 

The company has been owned by Vista since 2018, and was purchased with the help of a $600m annual recurring revenue (ARR) loan led by Golub Capital, with Ares and Blue Owl also in the 10-strong lender group. The facility had an interest rate of L+500bps.

This announcement followed another headline-grabbing tech acquisition: Nasdaq’s purchase of Adenza for $10.7bn, from current sponsor Thoma Bravo. 

Adenza was a combination of Calypso Technology and AxiomSL. The original Calypso acquisition in 2021 was financed with a $2.3bn unitranche led by Blue Owl. The final debt sum was priced S+575 and had a total of 13 lenders in the group, according to our sources; unlike Apptio, this was a regular-way cashflow deal, as opposed to an ARR loan. 

These acquisitions go some way to vindicating a philosophy of lending that became popular over the past decade or so. 

Financing tech companies means getting on board with a high-growth strategy, where companies spend huge amounts on marketing and R&D in their pursuit of scale. Revenue is subscription-based, and therefore sticky, and can provide a path to high profitability down the line; borrowers who took out ARR loans can then flip to regular cashflow deal.

Many of the big unitranches of recent years have been to tech companies, whether ARR loans for negative-EBITDA borrowers, or regular cashflow loans to companies that are already profitable. Think of the $5bn financing package for Zendesk, the $2.6bn loan for Coupa Software and a $2.5bn financing for Anaplan, among many others. 

“If you look at the big picture, in the last five years in North America, software deal activity has tripled,” said Oliver Thym, a partner on the private credit team at Thoma Bravo and speaking broadly about the tech lending market, in an interview with 9fin.

“It’s a growth industry and the reasons we love it on the credit story is the sticky, predictable subscription-based business model,” he added.

Different seasoning

It’s especially notable that those three deals — Zendesk, Coupa and Anaplan — were all completed in 2022, because the tech sector has taken an absolute shellacking over the last 18 months.

The frothy valuations of the ZIRP era started to fall off early last year, and even more so after Russia invaded Ukraine. The pandemic was good for many tech companies, with remote work boosting demand for all types of software, so sales fell as Covid receded; rising rates and the war in Europe then exacerbated the risk-off sentiment and added extra macro volatility. 

In private credit, tech borrowers had to pay up for financing to reflect this new reality. Avalara, which obtained a $2.5bn debt financing in the fourth quarter of 2022, paid a margin of S+725bps. Coupa, also a fourth-quarter deal, paid S+750bps.

This is well above the sub-600bps margins that Apptio and Adenza paid, which reflected the exuberance of pre-2022 or pre-pandemic dealmaking. In time, we may see Avalara and Coupa refinance at lower rates, but for now at least, private lenders are reluctant to go below 600bps even for promising tech companies.

On which note: it’s important to point out that software is a meta-sector as well as a sector in and of itself. Vista Equity founder Robert Smith once famously said that all software “tastes like chicken”, but the recent selloff has put a dent in that narrative. 

When underwriting a software firm, lenders have to think not just about the company itself but also about the sectors the company sells to, whether it’s business services, or healthcare, or real estate, or midwestern HVAC companies. Not all those sectors are the same, neither are they subject to the same pressures.

Nevertheless, there is a common theme to subscription software businesses, which is that for many clients they are an essential service. Although the flavor and seasoning may vary substantially, Vista’s chicken analogy has a solid basis.

“These tools and products are being sold into all end markets, and help companies improve their operating efficiency,” said Thym. “For these companies, spending on software is not in their discretionary spend — it is a requirement for these companies to run their business.”