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Recent financial distress in large, private equity-owned software companies is being misattributed to the threat of AI. The actual cause is over-leveraging when interest rates were low, followed by an inability to service that debt as rates rose and growth slowed. It's a credit problem, not a technology disruption problem.
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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.
Private credit funds are exposed on two fronts: they are financing the massive debt rounds for AI infrastructure and also hold debt for traditional SaaS companies. As AI companies pitch a future where they render SaaS obsolete, it creates instability and default risk across these private credit portfolios.
The "canary in the coal mine" for private credit isn't SaaS debt but any over-leveraged company. A firm burdened by debt repayments lacks the capital to invest in AI and automation, making it vulnerable to disruption by less-leveraged, more innovative competitors in any industry, not just software.
An expert warns of a "mini bubble" where private credit funds lent heavily to PE firms buying unprofitable software companies based on high ARR multiples. With falling valuations, AI disruption, and a wall of debt maturing, a wave of defaults and restructurings is imminent.
A significant, under-the-radar headwind for tech M&A is the instability in the private credit market. Private equity firms, which rely on borrowing to finance large software acquisitions, face higher loan costs and investor uncertainty about the long-term value of software companies. This financial friction is stalling deals that would otherwise happen.
Current tech layoffs are misattributed to AI. The real causes are the "wild" hiring binges during the zero-interest-rate COVID period and the rapid increase in the cost of capital. Companies are now correcting for that bloat, using AI as a "silver bullet excuse" for cuts that were financially necessary anyway.
While AI growth seems organic, low interest rates encourage even healthy companies to take on excessive debt. This is happening now, with some AI-related firms seeing decreasing free cash flow as leverage increases. The private credit market is already showing signs of nervousness about this trend.
A significant portion of private credit is concentrated in software companies. Many of these loans were made when rates were low, often with high leverage and weak terms. The emergent threat of AI-driven disruption to their business models now adds a new layer of fundamental risk to this already vulnerable cohort.
Beyond the long-term threat of AI disruption, highly leveraged, lower-quality software companies funded by private credit face a more immediate problem: a $65 billion wall of debt maturing by 2028. They must refinance this debt amid high uncertainty, creating significant near-term risk separate from AI's eventual impact.
Roughly one-third of the private credit and syndicated loan markets consist of software LBOs financed before the AI boom. Goodwin argues this concentration is "horrendous portfolio construction." As AI disrupts business models, these highly levered portfolios face clustered defaults with poor recoveries, a risk many are ignoring.
