Private Credit Opportunity: Software as a Service Lending

According to a survey conducted by Crystal Capital Partners among its client base of Independent Financial Advisors, 60% indicated plans to increase their allocation to private credit. This finding underscores a growing focus on income, with many individuals uncomfortable relying solely on traditional fixed income. This shift is not surprising given the impressive rise of private credit, which grew from less than $600 billion in assets under management (AUM) in 2013 to nearly $1.6 trillion in 2023, according to Cambridge Associates. With this growth, many new entrants are swiftly building private credit teams to capture a share of these flows.

The middle market, comprising companies with EBITDA between $10 million and $100 million, has emerged as the most compelling segment for private credit lenders, Nuveen Institutional reports. These companies often cannot rely on traditional banking channels for financing, especially after the stress banks experienced in 2023. Private credit has stepped in to fill this void. Typically, these loans have maturities of 5-7 years and feature floating rate coupons using the Secured Overnight Financing Rate (SOFR) plus a spread.

A particularly interesting segment of this market is lending to Software as a Service (SaaS) companies. These companies have a strong tailwind as organizations continue to increase their year-over-year IT spending. With the rollout of AI applications to the public and the persistent importance of cybersecurity, IT spending is unlikely to slow. Many SaaS companies exhibit strong revenue growth, established product-market fit, and high levels of recurring and/or contracted revenue. While these companies may have been traditional targets for private equity, they are increasingly choosing private credit markets for growth financing, rather than solely seeking dilutive equity capital.

At current SOFR levels, these loans can yield over 10% and often include equity warrants or convertibles. However, not all lenders can source these opportunities. Established private market managers, many of whom also invest in the equity of software companies, have proven their ability to source and capture these opportunities. This is partly due to their large teams focused on value-added services such as optimizing operations, sourcing accretive M&A, and other specialized expertise.

As companies' IT spending grows and more software is integrated into core operations, we believe the opportunity set in SaaS private credit will endure. Established investment managers will continue to have a competitive advantage in this space. This subset of private credit remains incredibly compelling for advisors seeking attractive current income and additional total return potential.