Software contracts, first-lien debt and the reality that no revenue is truly recurring.

Gavin Baker
5 min readMar 22, 2020


Robert Smith, CEO and founder of Vista Equity Partners famously said: “Software contracts are better than first-lien debt. You realize a company will not pay the interest payment on their first lien until after they pay their software maintenance or subscription fee. We get paid our money first. Who has the better credit? He can’t run his business without our software.” He used this insight — which has been absolutely correct to date — to build one of the most successful private equity firms in the world and generate exceptional investment returns.

We are about to find out if Robert Smith’s insight holds true during what will likely be the worst recession in recent history. Some customers, and perhaps some industries, are going to have zero revenue for an indeterminate period of time. As I have written, I believe it is likely that America and world will begin to slowly restart no later than Memorial Day. Unfortunately, that is over two months away and there will be a lot of economic hardship and bankruptcies in the meantime. Regardless of how long this economic hard stop lasts, I don’t believe anyone — investor or executive — underwrote the scenario we are living through. We are going to see if software contracts actually are “better than first-lien debt.”

My instinct is that software contracts will be at best comparable to first-lien debt and that software payment terms will change significantly as a result of this recession. I suspect that fewer customers will pay cash up front and that we will see payment terms lengthen significantly. A slowdown in revenue growth accompanied by a potential paradigm shift in working capital will have a substantial impact on software companies that are burning a significant amount of cash. Generating at least $1 of free cash flow has never been more important and getting to that magic first $1 just became much harder.

SMBs that have gone out of business — and there are already quite a few — will not be paying their software bills. I’m not certain that businesses that are effectively shut down like most physical retailers, restaurants, hotels, airlines and almost all remaining SMBs will be paying their software bills on time. A survey of 500 businesses published by AvidXchange on March 18th found that only 54% of businesses had the technology necessary to even pay a bill remotely. It is my understanding that some private equity firms are asking their portfolio companies to stop paying all bills. No cash out the door.

More broadly, software contracts will be adjusted to reflect lower utilization rates and fewer seats. Software wasn’t significantly impacted during the global financial crisis, but that was very different than the recession we are living through. The world did not stop the way it has over the last 10 days. Another critical difference between this recession and the financial crisis is that over the past 12 years software has become a much larger percentage of GDP as a consequence of “Software eating the world.” This mathematically makes software more cyclical. In the same way that internet advertising (unscathed in 2008–2009) will likely be more cyclical now that it is a higher percentage of overall advertising budgets and GDP, software will be more cyclical now that it is a higher percent of GDP. saw its revenue growth decelerate from 44% in their January 2009 fiscal year to 21% in their January 2010 fiscal year. I think we will see at least this much revenue growth deceleration across a broad swath of software names over the next twelve months and would not be surprised to see negative revenue growth from some software companies.

The degree of cyclicality for each software company will depend primarily on five variables.

First, it will depend on the size of their customers, as large companies will be much more resilient than SMBs.

Second, on their industry mix — i.e. travel related companies are going to be under much more pressure than companies benefiting from America working from home such as SVOD providers, grocery chains, e-commerce companies, videogame companies, etc.

Third, on their go to market strategy. Any software company that has a true enterprise sales motion is going to be challenged in this environment, while those that have freemium or e-commerce-like distribution models are going to be advantaged. For me, net revenue retention has always been one of the important software metrics — but it will be even more critical over the next 6 months. If gross churn spikes on a large revenue base, recovery will not come easily. Conversely, if a majority of a software company’s incremental growth comes from the installed base with continued low churn, it will be much easier to manage through this.

Fourth, on the actual hard ROI of the software. This will differ by customer, by industry and by where each software company sits in the “stack” for each customer and industry. Security, infrastructure, DevOps, service desk, collaboration, communication, CRM, marketing and HCM will all be impacted differently across industries and customer types. We will find out which software companies actually are “systems of record” without which companies cannot function.

Fifth and finally, on their pricing model. Seat based, transactional and workload based pricing models will obviously immediately feel the changes in the economy and naturally be more cyclical — one way or another. Some seat based, transactional and workload based companies will benefit, others will be hurt by the current economic situation. It is hard to frame the impact by pricing model but it will ultimately come down to utilization. Utilization will matter even for seat based models if the customer can cut seats, and utilization will matter in the context of minimum threshold deals.

The overall impact will be a multivariate output of all these factors: customer size, industry mix, go to market, hard ROI and pricing model.

Over the near term, at a minimum, discounting is going to go up significantly to help end customers, to reduce churn and to help sales representatives hit quota — or miss by less. Longer term, software contracts were already moving away from multi-year subscription models billed upfront towards usage based models billed in arrears which is consistent with hyperscale IaaS. The current recession will accelerate this transition, which will have a significant impact on software working capital dynamics and cash flow. But over the next few months, in a world in which mortgage payments, taxes and student interest payments are being deferred I’m not sure that software companies will be able to insist on payment or that it would be wise to do so. As bad as worsening payment terms might be for some software companies, the software industry would not want governments to begin including software bills on their list of expenses for which deferral is mandated. As Nachkari pointed out on Twitter, “contracts are only as good as the counterparties credit.” At the end of the day, there is no such thing as truly recurring revenue. Some revenue is just more recurring than other revenue.



Gavin Baker

Founder, CIO & Managing Partner, Atreides Management LP. Former Portfolio Manager, Fidelity OTC Fund. No investment advice, views his own. More: