Ankur Gupta, PNC's Global Head of Technology Finance, delves into the intricate world of tech lending. He explains what constitutes a 'good fit' deal and outlines the expectations during due diligence. The discussion highlights the importance of Gross vs. Net Retention metrics and how they influence loan values, along with the growing emphasis on recurring revenue in lending. Gupta also navigates the competitive landscape and offers insights on negotiating loan terms in a high-interest environment, showcasing the evolving dynamics of financing for software companies.
Addressing technology debt is crucial for software companies to maintain long-term stability and improve operational efficiency.
Private equity firms significantly influence the technology lending landscape by requiring a strong equity commitment from sponsors for financing deals.
Key metrics like gross dollar retention and the rule of 40 are essential for lenders in evaluating the viability of software businesses.
Deep dives
Understanding Technology Debt
Technology debt refers to the cost associated with choosing an easy solution now instead of using a better approach that would take longer. In the context of software and tech companies, this debt manifests when firms prioritize short-term gains over long-term stability and efficiency. Companies may cut corners in product development or postpone system upgrades, which can lead to increased challenges down the line, making it harder to innovate or scale effectively. By addressing technology debt proactively, businesses can improve operational efficiency and reduce future costs.
The Role of Private Equity in Technology Lending
Private equity firms play a significant role in the technology lending landscape by backing software companies. Lenders often prefer to finance firms with institutional ownership, as a strong equity check from private equity sponsors assures them of commitment and resource availability. The typical lending practice involves assessing companies with varying levels of equity ownership while ensuring at least one major investor holds 30% or more to secure confidence in the deal. This relationship-centered approach to lending emphasizes long-term collaborations between lenders and sponsors in the private equity space.
Market Shifts and Deal Structures
The lending market has seen fluctuations, particularly post-2020, with deal values and counts dropping significantly. During 2021 and 2022, a peak in sponsor activity was noted, leading to increased financing for founder-led businesses. In recent times, many lenders are exploring refinancing opportunities, either to lower costs or support underperforming companies due to macroeconomic factors. The current environment encourages a careful evaluation of creditworthiness, thereby ensuring that adequate funds are allocated based on sustainability, rather than on speculative growth projections.
Evaluation of Software Business Metrics
When assessing software businesses for lending, specific metrics such as gross dollar retention and ARR growth are critical. Lenders favor businesses demonstrating a strong gross retention rate above 90%, providing evidence of customer loyalty and product value. Additionally, the rule of 40 principle, which combines growth rates and profit margins, serves as a significant guideline for determining a company's health and ability to sustain. By leveraging these key metrics, lenders can differentiate between viable investments and those that present potential risks in the current market.
Navigating the Competitive Lending Landscape
The lending market, especially for software businesses, features both traditional banks and private credit sources, each with distinct advantages and trade-offs. Private credit providers often offer higher leverage but come with increased costs, whereas banks typically present lower interest rates with less flexibility. As competition intensifies, companies must carefully evaluate their financing options, considering factors like prepayment penalties and the overall cost of debt. Building strong relationships with lenders can lead to better terms and a smoother borrowing experience, enabling companies to adapt and thrive.
Devin spends an hour with Ankur Gupta, PNC's Global Head of Technology Finance, to discuss the current state of software company lending. We cover where PNC fits in the lending landscape, what a "good fit" deal looks like, what you should expect during due diligence, what covenants you should expect, and where pricing is across different lenders these days. We also cover how lenders think about Gross Retention vs Net Retention, ARR to loan values, and growth vs. profit.
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