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Private credit and software trends: Where does Vista Credit Partners see it going?

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David Flannery, President of Vista Credit Partners (VCP), discusses VCPs’ unique strategy, including its founder-direct offering, as well as his outlook for the private credit market and why software is an attractive investment opportunity.

VCP provides a multi-product credit platform investing across leverage credit markets, including new issue, secondary, syndicated credit, private credit and more. Within private credit, VCP provides financing to software companies from non-sponsor or founder owned growth businesses to more mature lower growth PE Buyouts.

Q: Tell us about Vista Credit Partners, your role, and how the platform differentiates its strategy.

Hi, I’m David Flannery, the President of Vista Credit Partners. Most investors know Vista Equity Partners. We’re the world’s most active enterprise software investor, and we manage over $70 billion in AUM (official AUM as of 3/31/21 is $77 billion). For 20 years, we focused on one thing with no style drift. With that focus, we’ve built the leading domain expertise in software investing. Importantly, we closely track thousands of software companies.

Vista Credit was founded in 2013. We’re a credit-focused capital solutions provider for software data and tech enabled companies. We’re differentiated not only because we are sector focused but because of the close connectivity with Vista’s expertise and the vast network developed over 20 years. Vista Credit’s value proposition is about bringing together the power of the platform and a group of world class credit investors. We’re harnessing that real synergy.

We work across our ecosystem constantly, looking for the best relative value, the best risk reward.

In the current market, we see the best risk reward in non-sponsor private transactions, a large focus for us. To be more specific, our operating plan and our differentiation is to do the industry leading share of non-sponsored deals. How are we doing? Well, five years ago, we were investing almost exclusively in sponsored financings, when there was spread premium to be earned in sponsored tech. But over the past year, we’ve closed on well over a billion dollars in founder direct, our term for non-sponsored transactions, across the platform. And that share is growing quickly. We’re winning at founder direct with the help of the Vista PE teams for sourcing and the Vista Consulting Group for highly specialized due diligence.

Q: Why should investors be looking into private credit, and what market conditions are most strongly affecting strategies and decisions in the space?

I think it’s generally agreed that when done well, private credit offers differentiated sourcing of deals with a more fulsome underwriting. Private credit also offers structural benefits and yield premium to liquid markets. We think the best example of yield premium with very little excess risk is a non-sponsor. Specifically, while private equity firms have become incredibly efficient at raising capital, non-sponsor companies are less efficient, less experienced at capital raising and creating opportunities in the private credit markets. They also care a lot who their partners are.

So while many LP partners have their core private credit managers in place, we think there’s a compelling case for a small group of specialized managers to supplement the core. We see alpha generation in the specialty and niche markets. As markets continue to become more and more efficient, we believe that to consistently outperform, GPs need to be exceptional at something. The generalist model may be getting crowded. Specialization and focus leads to differentiated deal opportunities. The economic terms and risk profile of unique deals is evident. As an example, when VCP meets software founders through our PE teams, many founders don’t actually realize that there are solutions from us that go well beyond bank lines for working capital needs. Again, as an example, the deal profiles that we’re creating have an average 20% loan to value, so some of the industry leading low LTVs, 10% running yield to maturity, some of the best maintenance covenants in the market, and we’re getting warrants from vetted equity upside potential in great software businesses. We think this is some of the best risk-reward in developed markets.

And we believe we are taking less risk than a portfolio of LBO financings. Why? For one, the specialization in Vista Credit’s case creates an opportunity for deal underwriting to be true PE style diligence. In our founder-direct deals, we have Vista Consulting Technology do the due diligence on the tech stack and on the company’s tech team. We don’t know of any other GP with that inhouse capability.

One last point on risk profile. While we call this practice founder direct, because we do focus on the founders of software companies who are most sensitive to dilution, these companies have highly institutionalized boards of directors and have taken several rounds of equity from some of the best-known growth equity investors in Silicon Valley.

Q: What trends are you observing in the technology and enterprise software space that make software an attractive investment opportunity for private credit?

There really are several software trends to highlight, but I think I’m going to discuss two. One would be the resiliency and predictability of enterprise software companies. and the other would be a developing willingness in Silicon Valley to optimize balance sheets and funding sources. So, first on resiliency, for 20 years Vista has evangelized the idea that enterprise software has resilient, predictable revenue and cash flow, importantly, with built-in organic growth. Enterprise software companies often have two- and three-year contracts with their customers, some with auto price escalators. So, at the start of a year, we have great visibility into annual revenue. 2020 tested that in a way that we could not have predicted, and enterprise software performed exceptionally well. At Vista Credit, we pick the best software businesses with mission critical B2B software and very low churn. Our credit portfolios performed exceptionally last year. To give you a sense, 60% of our credit companies, and I’m giving you pretty round numbers now, had revenue growth year over year, and 30% had flattish revenue performance. You might almost think I was talking about a different year, but that was in the heart of the pandemic. Our best performing subcategory last year, founder direct, the non-sponsored business I’ve talked about. That’s where some of the strongest organic growth opportunity is. So, again, we’re convinced we are taking less risk than most generalists.

On the second trend – funding – we see founders and their boards being much more open minded about less dilutive capital solutions than they were even three years ago. So, you can imagine most of Silicon Valley has grown up thinking that to scale you get a working capital line from a bank and then raise more equity. Like most markets, private software is becoming more and more efficient in the ways companies engage in optimal funding strategies and a willingness to use debt or other structured solutions. We believe we have just begun a long cycle of financing non buyout software. Our competitive advantage is over 100 Vista private equity professionals who spend everyday meeting and developing relationships with founders. And not every founder is ready to do a majority private equity transaction. Not even close.

Q: What’s the next big thing in private credit?

We think private credit has proven itself as a long-term asset class. If you’re a borrower, there’s a need for private credit solutions. And we’ve talked about the appeal to investors managing a portfolio allocation. I think the next chapter to play out in private credit is seeing the power of established investment platforms really winning. The GP winners need to take advantage of four things. One: their own vast networks to find differentiated sourcing, which may need to be specialized. And I think that reach needs to go beyond a group of credit originators covering PE shops. Two: leverage inhouse domain expertise and intellectual capital in their underwritings. Three: offer value add beyond capital to portfolio companies. Treat the companies like real partners, and help with strategy, a lot more than just buying networks at reduced costs. And four: better risk management and workout capabilities. When things do occasionally go sideways, what expertise, what operational experience can you offer to help fix a mistake before it becomes a problem? You can see where this applies to Vista Credit. As an example, we recently closed a $223 million deal for RocketLawyer, a cloud-based technology platform that is changing how people and SMBs get access to legal advice and manage risk. We sourced RocketLawyer through the Vista PE team. We had Vista Consulting do the tech and go to market due diligence, and we’re on the board trying to help the company think through strategic opportunities in the market. If you leverage that tool set, you can play successfully at all points in the capital stack. That’s the winning formula going forward.

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