Private equity firms, which heavily invested in software companies for their stable earnings, are now in a bind. The AI threat devalues these assets and complicates exits, forcing them away from traditional IPOs and toward more complex M&A strategies.

Historical analysis of distressed cycles in sectors like energy and retail shows that roughly one-third of the industry's debt defaulted over a two-year period. Applying this precedent to the software sector, which has approximately $300 billion in debt, suggests a potential default wave of around $100 billion if current pressures continue.

Apollo's co-president bluntly stated that valuations for many lower-quality software companies taken private during the ZIRP era are inflated. He predicts loan recoveries as low as 20-40 cents on the dollar for these assets, signaling a major correction.

While public software stocks have dropped 20-30% on fears of AI disruption, credit markets, particularly private credit, remain confident. Lenders are protected by low leverage multiples (1-6x EBITDA) and a substantial equity cushion, making them less sensitive to equity valuation shifts.

The greatest systemic threat from the booming private credit market isn't excessive leverage but its heavy concentration in technology companies. A significant drop in tech enterprise value multiples could trigger a widespread event, as tech constitutes roughly half of private credit portfolios.

As over-leveraged software companies fail, a new investment class will emerge. "Software special situations" funds will acquire these distressed assets from creditors, abandon growth-at-all-costs, and focus on restructuring for profitability and dividends, akin to a Constellation Software model.

Angelo Ruffino of Bain Capital forecasts that default rates in the software lending sector will significantly exceed the broader leveraged loan market average of 4-5%, potentially reaching high single-digit or even low double-digit percentages due to AI disruption and over-leverage.

A significant portion of private credit portfolios consists of loans to software companies, which were underwritten based on predictable, recurring revenue. AI is now fundamentally disrupting these business models, threatening to devalue the very collateral that underpins billions of dollars in these 'safe' loans.

Private credit funds have taken massive market share by heavily lending to SaaS companies. This concentration, often 30-40% of public BDC portfolios, now poses a significant, underappreciated risk as AI threatens to disintermediate the cash flows of these legacy software businesses.