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From recurring revenue to sticky customers: The trends driving tech sector issuance

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  • Leverage loan technology and computer-related issuance in Western and Southern Europe almost doubled from annual pre-pandemic levels to €19.9 billion by the end of 2021
  •  Technology and computer-related high yield bond issuance in the region hit an all-time high of €7.3 billion by the end of 2021
  • Start-up debt issuance in Europe had already reached a record annual total before the end of Q3 20211

Europe's technology industry went from strength to strength in 2021, with M&A and lending activity in the space thriving as investors across multiple asset classes tapped into the tech sector's non-stop growth and resilience.

The shift to home working due to COVID-19, as well as the rise in digital learning and online shopping and entertainment through both 2020 and 2021, drove earnings growth across the entire technology sector.

Safe and secure technology was a must-have in every home, which ensured that tech firms were kept busy, lifting revenues and prompting tie-ups. This in turn created opportunities for cybersecurity firms—Dealogic data shows 57 cybersecurity-related M&A transactions in Europe in all of 2020 versus 69 deals in 2021.

Fintech firms were also quick to see the benefits of an accelerated shift to things like online banking and contactless payments. This trend has been growing steadily for years but attracted particular attention in 2021, spurred on by an explosion in special purpose acquisition company (SPAC) dealmaking. As a result, fintech-focused Pegasus Europe and EFIC1 were two of Europe's largest SPAC deals in 2021.

The evolution of business models built on stable recurring revenues (from Netflix to Spotify) and sticky customer bases (from Intuit tax software to Shopify) only added to the sector's appeal for investors looking to mitigate downside risk. 

These strong underlying drivers saw the STOXX Europe 600 Technology Index climb 25% in the 2021 calendar year, outperforming the STOXX Europe 600 by around 7%.

M&A activity was equally buoyant for the sector, with the 488 technology buyouts totalling €49.2 billion in 2021, accounting for nearly a third of all European private equity (PE) deals, according to Mergermarket data.

Across all technology verticals, from fintech to cybersecurity, investment levels are moving steadily upwards—a trend that shows no signs of slowing in 2022.

The strong performance of the sector makes it highly attractive for leveraged loan and high yield investors. For technology borrowers positioning their businesses for an acquisition, debt markets have been a useful source of capital to fund their growth before M&A deals clear.

Technology and computer-related leveraged loan issuance in 2021 came in at €19.9 billion in Western and Southern Europe, according to Debtwire Par. This was well ahead of the 2020 full-year total of €13.8 billion and almost double the €10.6 billion in issuance posted pre-pandemic in 2019.

High yield issuance for technology and computer-related credits was equally robust. Debtwire Par data shows that, in 2021, issuance in the region reached an all-time high of €7.3 billion, exceeding the previous annual record of €4 billion posted in 2018 and almost trebling the annual issuance of €1.7 billion in 2020. 

Startups are stepping up in debt markets


Technology and computer-related leveraged loan issuance in 2021 was 44% higher than the 2020 full-year total

Lenders are so enthusiastic about hitching their wagons to the technology sector that they are exploring new channels and debt products to increase their exposure to a wider pool of potential borrowers.

Debt provision for startups, for example—which is structured to provide fast-growing companies that are not yet cash-flow-positive with access to debt financing—hit record levels in 2021, as growing interest from tech startups and a rising number of new entrants on the lender side saw issuance climb.

According to figures from database management company Dealroom, European startups raised €8.3 billion in debt before the end of Q3 2021. This is a 41% uplift on the €5.9 billion of funding secured in the 2020 calendar year and ahead of the previous record annual total of €8.1 billion secured in 2017.2

Venture and start-up debt penetration in Europe has been a fraction of that in the US historically, but there are now signs that European markets are closing the gap. Borrowing by startups in Europe has more than quadrupled since 2015, when the market was only worth €1.6 billion, and uptake is now growing at double the rate of the US.3

Debt financing provides start-ups with lines of capital that do not dilute existing shareholders and allows companies to build up their credit history. This is vital for businesses planning to tap into mainstream debt markets later in their development. For lenders, the product provides exposure to a fast-growing technology credit early in the development curve. 

Industry surveys show that start-ups that use venture debt products are likely to do so again.4 Given the stickiness of the product, as well as new entrants entering the market and driving down pricing, the growth runway for start-up debt in Europe looks promising.

Recurring revenue structures come to the fore

For mature technology assets that are too large for start-up debt financing but have yet to reach sufficient scale to access leveraged finance markets, the emergence of recurring revenue debt provision has provided a valuable option for raising capital.

Recurring revenue debt unlocks additional funding by providing credit on the basis of repeatable or subscription-based revenues. The product has been a good fit for technology companies that supply business-critical software and services that clients rely on for the day-to-day operations of their companies. Lenders have been able to provide capital to these borrowers using recurring revenue structures, even though the companies are not yet EBITDA-positive.

Terms and pricing vary from credit to credit, but recurring revenue loans will typically price higher than vanilla loans and have a runway of between two or three years. The expectation is for the credits to reach profitability and graduate to conventional cash flow lending options in that time. 

This financing strategy has helped fast-growth late-stage, venture-backed technology companies to bridge to an IPO or build profitability. 

New lending streams like venture debt and recurring revenue loans have been well received by European technology startups. With lenders eager to tap into the sector's strong growth fundamentals, the year ahead is likely to break more records as European technology companies of all sizes have access to deeper pools of capital than ever before.

"Europe raises record amount of debt funding". Kai Nicol-Schwarz. Sifted. 7 September 2021.
2 Ibid
3 "Europe raises record amount of debt funding". Op cit.
The State of European Tech. Report. 2020.

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