Maria McGuire, commercial finance partner with Chicago law firm Goldberg Kohn, writes on technology finance and issues that arise in helping lenders structure transactions with technology companies and private equity firms with tech-focused portfolios…
For years, a limited number of lenders specialised in working with technology companies and private equity sponsors with technology-focused portfolios. Today, those lenders face dramatically increased competition. Software and technology may still be an industry of its own, but in recent years, software and technology companies have entered almost every sector of the economy; there seems to be a software application for every activity or process, and private equity firms and lenders have followed the changing landscape, increasing their focus on software and technology companies. As competition among lenders has increased, in order to secure transactions with these borrowers, lenders must demonstrate a thorough understanding of the specific needs and challenges faced by technology companies in the current market.
Successful lenders in this sector recognise that in the software industry, even more so than in other more traditional businesses areas, access to capital is critical to growth and, ultimately, survival. If software companies are not continuously investing in their products internally or acquiring new technology through third-party acquisitions, they risk being left behind by fierce competition. We can all identify technology companies that once led their fields but did not adequately respond to the demands of innovation and languished as a result. Once product and service offerings are outdated, it takes time and even greater investment to attempt a comeback, introducing additional risk to lenders and equity investors. Lenders must demonstrate willingness and ability to support their borrowers in their quest to remain competitive and to grow. Software and technology companies, often more than other borrowers, are acutely focused on and implement delayed draw term loan facilities, incremental credit facilities and permitted acquisitions.
Technology companies and private equity firms with portfolios focused on technology and software want partners with extensive experience in and knowledge of their industry. They focus on how their lender may assist them in developing new relationships and connections that benefit the business. In order to win transactions with these borrowers, lenders must demonstrate their capabilities in these areas. The right partner can provide resources to position a company to go to the next level, either by attracting a top-tier investor or purchaser, or through an IPO. Technology companies look for more intangibles from their lenders than many other companies looking for cash-flow or asset-based credit facilities.
Technology borrowers also look for lenders who understand that financial metrics used in other business sectors might not be the right metrics for them. For example, lenders to software companies must recognise that valuations based on EBITDA might not be appropriate and a valuation based on another metric, such as recurring revenue, might provide a more accurate indicator of financial performance. More and more software companies have adopted recurring revenue models, and lenders who fully understand and have the requisite experience with and knowledge to accurately evaluate recurring revenue find this to be an invaluable selling point with their borrowers. For companies in transition, they are also familiar with the process and understand the value of migrating from a software licensing model to a Software-as-a-Service model and the effect on revenue and cost recognition.
Finally, like all lenders, lenders to technology and software companies must understand their collateral and take appropriate steps to protect and secure their interests. They must engage counsel able to perform the necessary due diligence of the borrower’s intellectual property, including evaluation of borrowers’ internal practices regarding creation and development of their products, the effectiveness of steps taken by the borrows to protect their own interests, as well as a keen review of license agreements such as licenses of intellectual property owned by a third party and licensed to the company for use in its products sold to the end-user.
In order to secure deals with technology companies and private equity firms with technology-focused portfolios, lenders must demonstrate a deep understanding of their clients’ need to grow continuously, the value of their revenue stream and that the lenders have the relationships and can make introductions to further advance the success of their borrowers.
