Recurring Revenue Loans in Private Credit: Structures and Key Risks

Recurring Revenue Loans: Structure, Terms, Risks

Recurring revenue loans are senior secured term loans underwritten against a company’s annual recurring revenue – the subscription income it expects to collect each year – rather than current EBITDA. ARR is the contracted or strongly recurring portion of revenue, net of credits and temporary promos. Lenders lean on net revenue retention, churn, and cohort durability to get comfortable when EBITDA is small or negative during a build phase.

These loans are not revenue-based financing. RBF pegs payments to a percent of revenue. Recurring revenue loans follow a conventional interest schedule – cash pay and sometimes payment-in-kind – with an all-asset lien. They are also distinct from asset-based loans, which advance primarily on receivables and inventory. Here, lenders size against the predictability of subscription dollars, not liquidation proceeds.

Where Recurring Revenue Loans Fit – And Why Borrowers Choose Them

The fit is clearest in software and managed services. Many companies in these segments have sticky customers and strong gross margins, but they reinvest cash into growth. They want more debt capacity than venture lenders will offer and less dilution than equity. Borrowers trade that capacity for tighter reporting, sharp revenue definitions, and consent rights around how customers are billed and retained.

Lenders want diversified, high-retention books of business with clear unit economics. They price for two risks: ARR volatility and the chance the EBITDA crossover arrives later than planned. Sponsors accept that trade to buy time and avoid raising equity before they must.

Core Structures That Lenders Actually Use

Structures vary, but a unitranche term loan with a super-senior revolver from a bank is common. Delayed draw term loans fund acquisitions or capex when ARR and churn tests are met. Some facilities spring to EBITDA-based documentation after the business clears a negotiated EBITDA threshold, which lowers the friction of refinancing.

Sizing starts with ARR. The multiple depends on gross margin, net revenue retention, logo churn, cohort behavior, customer concentration, and the path to EBITDA. High-margin, diversified SaaS with net revenue retention above 110 percent earns a higher multiple than services-heavy or concentrated models. Documentation defines ARR tightly – no one-offs, no implementation fees, and caps on annualization. Most lenders rely on three or six-month average MRR annualized and put limits on including signed-but-not-billed contracts.

Cash Flow Waterfall and Collateral – What Gets Paid First

Cash flow priorities are straightforward: interest and fees first, then any required amortization, then optional prepayments, with distributions to equity controlled by restricted payment tests. Scheduled amortization is often minimal to preserve customer acquisition and product spend. PIK toggles appear when the loan is sized toward the upper bound and cash needs to stay in the business.

Collateral is an all-asset lien: receivables, contract rights, IP, deposit accounts, and equity of domestic subsidiaries. Customer contracts often have assignment limits, so the lien usually attaches to proceeds and general intangibles. Lenders lock down change of control, debt incurrence, liens, investments, and restricted payments with baskets tied to ARR. Consent rights can include material changes to pricing, renewal terms, termination rights, billing and collections policies, and acquisitions above a set size.

Reporting That Proves the Story

Reporting expectations are higher than typical cash flow loans at similar headline leverage. Lenders expect monthly ARR and cohort bridges, gross and net churn, logo churn, average revenue per account, billings-to-revenue and billings-to-cash reconciliations, deferred revenue trends, and collections. A third-party ARR audit at close and annually is now close to standard.

Covenants and Triggers That Keep Risk in Check

The core tests anchor to revenue and liquidity, because traditional coverage may be less meaningful early on:

Minimum ARR: Level or growth against a negotiated schedule.
Minimum liquidity: A mix of cash and revolver availability.
Retention and churn: Net revenue retention and gross churn thresholds to prevent masking attrition with heavy discounting or upsells.

A crossover mechanic flips to EBITDA-based leverage and coverage covenants once trailing EBITDA clears a set level and, in some cases, a leverage test. Cash dominion springs when liquidity falls below a threshold or specific defaults occur. Accordion and DDTL draws require ARR and churn compliance and no material spike in attrition. Equity cures are usually cash only – pay down debt or inject equity – not redefinitions of ARR.

Legal Forms, Enforcement Reality, and Cross-Border Nuance

In the US, Delaware corporations or LLCs are typical, with guarantees from material domestic subs and New York law documents. Security is perfected under the UCC with separate IP filings where needed. Foreign subs may be carved out or partially pledged to manage tax and dividend issues. In the UK and Europe, LMA-style English law facilities and local security apply. Data privacy, consent to assign, and customer notification rules matter in both diligence and workouts; they influence what you can do, and how fast, if performance cracks.

Do not expect securitization-style true sale or bankruptcy-remote structures. This is corporate debt secured by operating assets. Lenders usually require ring-fenced cash management with account control agreements and material subsidiary guarantees to reduce leakage. If enforcement is needed, a stock sale is often cleaner than a contract-by-contract transfer, but buyers will expect discounts in stress.

Economics, Fees, and a Simple Sizing Heuristic

Coupons reflect illiquidity and model risk. Base rates follow overnight benchmarks; SOFR sat around 5.3 percent in December 2024. Unitranche recurring revenue loan spreads run higher than classic EBITDA unitranche given ARR variability. Expect 2 to 4 percent original issue discount, an arranger fee at close, and unused fees on delayed draws. PIK toggles add 50 to 150 bps when turned on. Call protection often combines a 6 to 12 month make-whole followed by a 101 to 103 soft call over one to two years. For context on lender returns and pricing mechanics, see this overview of direct lending in private credit.

Illustration: a 100 million dollar facility at SOFR + 675 bps with 3 percent OID and a 50 percent PIK toggle, plus 1 percent on a 30 million dollar DDTL commitment. With SOFR at 5.3 percent and PIK off, the cash-pay coupon is about 12.05 percent. OID adds roughly 150 bps to yield over a four-year average life, and undrawn DDTL fees add 30 bps on the 30 million dollar commitment. If the PIK toggle is on for year one, cash interest drops by 50 bps while total yield rises.

Original angle – a quick guardrail for committees: a retention-adjusted multiple can keep size reasonable. As a rule of thumb, Maximum recurring revenue loan ≈ ARR x gross margin x min(1, net revenue retention/110%) x 2.5 to 3.5. It is not a covenant, but it disciplines underwriting to margin and retention quality.

Tax and Accounting Touchpoints You Cannot Ignore

US borrowers should assess 163(j) interest limits. PIK still counts as interest for tax, but it increases basis rather than cash taxes. Watch AHYDO risk on high OID or stacked PIK; documents often cap PIK and OID to avoid it. UK borrowers face the corporate interest restriction. Cross-border interest may need treaty relief or portfolio interest eligibility; draft gross-up clauses carefully to avoid tactical status changes by lenders.

Borrowers book these loans as debt under US GAAP and IFRS with effective interest method amortization for OID and fees. PIK accrual increases the carrying amount. Material repricings or maturity moves trigger modification or extinguishment analysis. Convertible or warrant features require bifurcation tests. ARR, MRR, net revenue retention, and churn are non-GAAP; align them with ASC 606 or IFRS 15 revenue policies and lock the definitions in the credit agreement.

Regulatory and Process Considerations

Private credit managers in the US file under the Advisers Act, with enhanced Form PF items around leverage and terms. New beneficial ownership reporting under the Corporate Transparency Act applies to US entities formed in 2024 or later. Banks providing controlled accounts will run KYC and AML; lenders often screen large customers during diligence for process certainty.

In Europe, AIFMD governs marketing and leverage disclosures. GDPR and other privacy laws shape what data can be shared and how enforcement works. Consumer-facing businesses need a close read on auto-renewal and cancellation rights.

Risk Factors That Matter Most

ARR quality: Loose definitions can let in promos, credits, or rolling trials that do not renew. Tight definitions and audit rights reduce that risk.
Churn and cohorts: Gross churn and logo losses can overrun upsells. Cohorts signed at peak pricing may downgrade at renewal.
Concentration: A single customer above 10 percent of ARR increases renegotiation leverage at renewal.
Services mix: High professional services content inflates GAAP revenue but not ARR.
Billing to cash: Slippage lengthens DSOs and raises write-offs; policy changes can hide delinquency.
Covenant creep: Overly generous pro forma inclusions and soft crossover triggers delay interventions.
Data integrity: Manual spreadsheets and weak controls lead to reconciliation gaps. Require system audit trails and lender recalculation rights.
Alignment: Thin equity and fee leakage dull cure incentives. Use fee blockers or baskets tied to ARR and liquidity.

Comparisons and Alternatives Worth Weighing

Venture debt: Works well at smaller sizes and alongside equity. It usually relies on investor support and runway, not ARR. Recurring revenue loans provide more capacity and tighter discipline.
Revenue-based financing: Flexes with revenue but struggles to scale or support complex stacks. Recurring revenue loans provide classic security and broader use of proceeds.
Asset-based loans: Help when receivables are strong but subscription quality is mixed. Recurring revenue loans finance the subscription engine that produces those receivables.
Traditional cash flow loans: Make sense once EBITDA is positive and steady. Many recurring revenue loans are designed to flip there.

Diligence Requests That Accelerate Close

Cohort tables: By logo and dollar for 24 months showing expansion, contraction, and churn.
Renewal calendars: Price and term shifts for the top 50 customers, including side letters and bespoke SLAs.
Billing extracts: Reconcile MRR to invoices and collections, including unapplied cash and credit memo trends.
Sales comp and discounts: Identify incentives that inflate quarter-end ARR.
Roadmap and pricing: Product plan and packaging shifts that affect ARR attribution.

Governance Levers That Move Risk

Money-in cures: Reduce debt or prepay software expenses tied to retention, not paper EBITDA cures.
Spend guardrails: Tie sales and marketing ramps to payback and cohort returns.
Concentration hedges: For large renewals, add credit insurance or escrowed deposits.

Execution Timeline – A Practical Eight-Week Plan

Weeks 0 to 2: Negotiate term sheet – ARR definition, pricing, covenants, and PIK mechanics. Provide cohort data, top-customer exposure, churn, and billings-to-cash.
Weeks 2 to 4: Launch independent ARR review. Counsel drafts the credit and security documents; tax reviews 163(j), withholding, and cross-border guarantees. Identify accounts for control agreements.
Weeks 4 to 6: Finalize intercreditor with the revolver bank, run systems walk-throughs, and lock reporting templates and covenant certificates. Confirm IP ownership and filings.
Weeks 6 to 8: Deliver ARR audit, updated cohorts, key contract summaries, insurance, approvals, and opinions. File UCC-1s and IP security, execute account controls, and fund the initial draw.
Post-close: Monthly reporting, quarterly lender sessions, annual ARR review, and alignment for the EBITDA crossover.

Documentation Trends to Copy

ARR audits: Conditions precedent at close and annually.
Churn sweeps: Sweeps after two consecutive quarters over thresholds.
Clean add-backs: Stricter add-backs and clear bans on pipeline ARR in covenants.
ARR-based increments: Incremental capacity tied to ARR and net revenue retention, not leverage-neutral math alone.

Fit Check – When Recurring Revenue Loans Work

They fit when the product is proven, gross churn is stable, customers are diversified, and the team shows a credible 12 to 24 month path to EBITDA backed by unit economics. They do not fit when services dominate, contracts are short or cancellable at will, concentration is heavy, or systems cannot produce reliable ARR metrics without manual patches.

Market Context and Pricing Signals

Subscription models remain durable, but upsell has cooled. Private SaaS surveys in 2024 show median net revenue retention around 100 to 105 percent depending on scale. That compresses ARR multiples and shifts attention to gross churn and logo stability. With base rates elevated, many facilities include PIK toggles and stronger call protection to manage liquidity while preserving lender yield.

Records and Closeout Discipline

Treat ARR audits, reporting packs, and covenant certificates like regulated artifacts. Archive the index, versions, Q&A, user access, and full audit logs; hash packages; follow retention schedules; require vendor deletion and destruction certificates; and apply legal holds that override deletion when required.

Key Takeaway

Recurring revenue loans unlock non-dilutive capital for sticky, high-margin subscription businesses before EBITDA matures. The best outcomes come from tight ARR definitions, disciplined reporting, retention-focused covenants, and a clear crossover plan. Price for variability and document the workout path on day one – it is the fastest way to yes and the best protection if growth slows.