David Flannery leads Vista Credit Partners, which is Vista’s credit investment strategy providing debt and structured equity financing to enterprise software, data and technology companies. LCD recently asked him about the balance between private debt and the syndicated loan market, the outlook for the technology sector, private credit market conditions and expectations for transaction volume for the remainder of 2022.

LCD: What degree of spread tightening is needed for the syndicated loan market to attract a H2 2022 deal currently being considered in the private debt market? Or is it not a matter of spread tightening, but rather the structures available in private credit that make them more attractive than a syndicated deal?

DF: This is less an absolute tightening of spreads than the persistence of volatility. As long as equities remain choppy, we believe the private debt market will continue to be more robust than the syndicated loan market. Simply put, borrowers want higher certainty, lower execution risk, and more efficient processes when seeking financing. This is exactly what attracts companies to the private debt market, especially today.

Do you expect an economic downturn to affect tech companies differently than other industries? How might that be with this group of corporate borrowers, especially in light of the recent trend towards recurring revenue loans?

It’s an interesting time in the market as we see the differentiation between enterprise software and consumer Internet businesses.

Enterprise software has been and always will be essential to running a business, regardless of market conditions. When businesses are well managed, they will have high customer retention rates and visible recurring revenue components. On top of that, there are tailwinds in the industry that we believe will continue to support enterprise software performance in a push towards digitization.

Even so, the question remains whether growth rates could slow in enterprise software. Businesses planning to install new software may take a little longer, which can slow growth, but only up to a point. As a lender, while we can tolerate some slowdown in growth, we care more about the sustainability of revenue, and therefore cash flow.

How would you characterize the current balance in credit markets between corporate borrowers and lenders?

We think the lending world is going to see some dispersion in enterprise software. There are tourists in this space, but not all tech companies are created equal. Identifying truly mission-critical enterprise software vendors is essential, and this factor makes them more resilient in these volatile market conditions.

In terms of balance, the private credit market is favorable to lenders given the volatility and uncertainty in equity markets, especially what we are doing with non-private business lending. Today, growing companies and their founders who want to continue investing in their business are increasingly looking for alternative capital solutions.

This momentum is driving demand for our less dilutive and flexible capital solutions, which we offer through our FounderDirect offering. (Note: FounderDirect, part of Vista Credit, specializes in founder-run enterprise software vendors.)

Many market players say activity has been slowing since the start of 2022. What are your trading expectations for the rest of the year?

Traditional sponsor-focused private credit managers have certainly seen some downturn due to lower M&A volumes. However, in this environment, given our unique FounderDirect capabilities, we have seen an increase in calls coming in from non-equity owned enterprise software companies. With an IPO market nearly closed, a choppy growth equity market and uncertain valuations, these dynamics are driving demand for our less dilutive FounderDirect capital solutions.

It goes back to the fundamental fundamentals of the business. Enterprise software involves a long sales process before a company buys or licenses a product, but once it’s up and running, customers rarely leave. Even though we are in an uncertain economic environment, the “rigidity” or mission-critical nature of enterprise software is why there will continue to be a market for lending these deals.

What innovations have you experienced in credit markets that have been particularly helpful for technology borrowers?

We leverage Vista’s deep domain knowledge, operational expertise, and extensive ecosystem, with all of its intellectual property, to create a unique solution for growing, successful, non-founder-controlled businesses that are seeking funding to continue executing growth initiatives. This is a critical segment for us in what we call FounderDirect, a tailored, tailored offering that helps us drive value beyond invested capital.

Typically, we are the sole lender in a FounderDirect investment, so the relationship between management and Vista Credit Partners (VCP) is considerably closer than in other credit or non-controlling investments with more active dialogue. We are able to deeply understand a company’s strategy and leverage the operational expertise, financial savvy and strategic thinking that comes with the Vista ecosystem to help a company succeed.

Given these close relationships, we believe we are well positioned to recognize and respond to early warning signals of degraded performance and tap into the resources of VCP and the broader Vista platform to collaborate with the borrower in order to potentially avoid negative outcomes.

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