ARR based lending

ARR-based loans are here to stay - as MM and UMM PE firms (Thoma, Vista, Advent, etc.) increasingly target smaller / higher-growth tech names that are either not yet profitable or currently generate 20% margins. ARR loans aim solve for the same funded debt as EBITDA-based deals; allowing them to access the capital needed to continue along the path to increased scale / maturation (as mature SaaS businesses generate margins in the 35-50% range). I would say the pricing premium is in the +50bps range on average (e.g., 2.75x ARR deal priced at +600 over would equate to +550 over for a 6.75x loan). On the covenant side, there is typically a Maximum Debt / ARR Ratio set at either a static level (atypical) or a 35-40% cushion to closing with 1-2 step-downs no earlier than 12-24 months post-close. Given the fact that the profitability is limited (or non-existent), there is usually a minimum liquidity covenant set in the ~$5MM range — to account for the inherent risk related to lending millions of dollars, equating to multiples of revenue, to an unprofitable business). The risk-reward from a debt perspective doesn’t honestly make much sense… however, there is typically a concept whereby the loan automatically converts to an EBITDA-based deal 3 years (36 months) post-close. However, even this is now getting wiped from negotiations to be based only on Borrower’s election / discretion or not at all (aka an ARR loan for life). The positive thing about these deals (from a debt perspective) is that these businesses typically trade for 10x+ ARR, so even if you are at a 3x attachment point, you are at 30% LTV… with a ton of equity beneath you. In short, ARR loans are here to stay — and will only become more aggressive (given: huge funds being raised by PE firms who need to expand their target universe to include smaller; coupled with tons of capital raised on the private credit side looking to deploy alongside top PE firms).