Private Credit and the Medallia Incident

Live from Schenectady, New York, it's the Metrics Brothers, Growth and CAC. And I'm Growth, better known as Ray Wright, founder and CEO of Benchmarkit.

And I'm CAC, better known as Dave Kellogg, EIR at Balderton Capital, independent consultant, and the author of Kelblog.

And we go together like credits and debits.

Yes, we do. Though I suspect today's episode will be a little less balanced.

You mean no double-entry accounting today?

No T-accounts, no trial balances, Ray. We're going to keep it simple.

That's a relief to me and to my wife.

But we are talking about credit, not credits, not the accounting kind.

So what kind of credit are we going to talk about?

Well, we're talking about debt generally and specifically private credit.

Ah, that's a term which seems to have gone from never really heard of it to it's everywhere all at once.

Indeed, it used to be boring and now it's headlines everywhere.

Exactly. But first, let's hear a word from our sponsor. The Metrics Brothers is proudly sponsored by Benchmarkit, the B2B AI and software industry's largest, broadest, and most contextualized benchmarking index. Dave Kellogg and Ray Grothright, Have put the Metrics Brothers podcast on hiatus for the remainder of 2026. All episodes we have ever recorded are still available on your favorite podcasting app. You can reach Dave at Kellogg and Ray on LinkedIn at Ray Reich. Thank you so much for listening to the Metrics Brothers podcast.

Okay, Ray, let me start out here with some basics on private credit. And then we're going to move into venture debt and direct lending. So private credit is non-bank lending done by funds instead of banks, typically structured like a VC/PE fund, but with a repayment mindset, not a returns mindset. So to me, when I first met a venture debt fund, well, it's got limited partners, it's got partners, it does deals, but those deals are not buying equity in venture-backed startups. Those deals are making loans to venture-backed startups. So what I'm referring to right there is what's called venture debt, which is a type of private credit.

Yeah. And to me, this kind of private credit is a standard tool in the PE financial toolkit. It's not just a niche product.

It is certainly like venture debt became standard, I want to say, 20 years ago, and private credit in software really blossomed with the M&A era. Because the type of private credit, also known as direct lending, that we're talking about is not just making loans to venture-backed startups, which is venture debt, but it's more backing M&A transactions, basically leveraged buyouts. They're the leverage, they're the L in LBO, right? Private credit, because they're making loans that allow the private equity firms to get leverage when they do Yeah.

Well, one of the things I did was a little research about why it's— everyone's talking about this all the time now, besides some of the risks that we're going to cover. But capital deployment in private credit, you know, it hit almost $600 billion in 2024, and that was an increase of 78% from 2023 deployment. And then in a SaaS article I read, it also said like 22 to 25% of private credit went to SaaS companies. So there was a lot of concentration there, Dave.

Yeah, the software industry went, I think, over the last maybe 30 years from being a relatively small part of private credit to being a very large part. And now, of course, another reason it's in the news is 'cause of the AI infrastructure buildout, not our topic today, but private credit is in many cases providing debt to people like Oracle to go build out these data centers. So people like Blue Owl, have been in the news today, but we're not going to talk about the AI buildout today. We're going to talk more classically about venture debt and basically private credit direct lending as part of M&A transactions.

Cool. So you want to talk a little bit more about the pricing and why it's higher than bank debt?

Sure. Why don't we just do the debt fundamentals here, Ray? So what is debt? Debt means you're borrowing money. When you borrow money, you pay interest on it. And you repay principal, and there is a charge from the lender that basically a premium for risk and illiquidity. These loans, in venture debt loans, are typically floating rate. They're quoted as a base rate plus a spread. So historically, that might be like LIBOR, the London Interbank Offered Rate, plus 500 to 800 basis points. Remember, a basis point is a hundredth of a percent, so 5 to 8 basis points.

Okay.

points, or 500 to 800 basis points if we want to sound like debt people. Um, today people usually do it off SOFR, or SOFR, the secured overnight financing rate, plus roughly the same spread of 5 to 8 points. So for example, today if you took SOFR, added 5%, that implies all-in borrowing costs of roughly 10 to 13%, uh, per year.

Yeah, but That's a lot different than it would have been in our ZIRP era, right? Where you had zero rate interest and it could have been, what, 4 or 5 points lower?

Yeah, yeah, it would have been down to, I think, as low as either 0.5% or 0.75%. So you throw 5 points on top. So you're talking about the difference between borrowing money at 5% and borrowing money at 10%, or maybe 8%, uh, versus 13%. Um, and those are some big differences there. Now, As it turns out, maybe let's put the venture in venture debt. So why isn't it just plain old debt? Well, what kind of makes it venture debt is first because they're loaning to venture-backed startups, but I like to think it's venture debt because they are taking some warrants on the deal. So they're saying, you know what, we're gonna loan you $10 million, we're gonna do it back in the ZIRP days, let's say at 6%, so pretty good rate for in normal times, but we also want some equity or some warrants that allow us to buy typically 10% to 15% of the loan amount, maybe as low as 5% to 15% of the loan amount, which when you look at the typical loan amount to the total value of the company might result in either 0.5% to 1% to maybe 1.5% ownership in the company. So, in my mind, these people are basically making pretty risky loans, right? They're making them to venture-backed startups. That spells risk. They're doing it with what I consider to be a nice risk premium, right? 5 to 8 points. But on top of that, if I hook into the next Uber, I'm going to make a ton because I've gotten warrants on maybe half a percent of the company.

Yeah. But at the same time, they're not trying to behave like VCs because, you know, a VC, you know, the famous saying is what? 1 or 2 companies produce the majority of the returns. Venture debt and private credit lenders, hey, they're not taking a bet on what happens with the equity. They have great structures where each deal on its own stand on its own and delivers positive cash returns.

Yeah, you need to have home runs if you're going to have strikeouts, right? So, so in VC, they rely on a couple of home runs. Like in a typical VC portfolio, there might be 1 or 2 home runs, you know, a couple of doubles, a couple singles, and 5 strikeouts. Uh, in a PE portfolio, they want like 8 base hits, 9 base hits, right? Maybe, maybe, maybe 1 double and 9 base hits, you know? Um, and in venture debt, they want 10 base hits, right?

Right.

Simple math. If you have a billion-dollar debt fund and you loan $100 million to 10 different companies, if one of those companies goes completely bust and you get nothing back, the total interest on the other $900 million is only $90 million a year. It doesn't offset That just that one year's interest isn't enough to offset one loan gone bad. So these people want to get their money back. And so I would say they're in the downside protection business. Um, and they do that through a number of means, which we'll talk about in a minute. But the warrant is really a sweetener, but the interest rate is the risk premium and very much worried about getting repaid.

Yeah, the warrant As you said, is a kicker. And the thesis is repayment on a high percentage of those deals. But one of the things I want to talk about was who are some of the major players who are providing private credit today? Sure.

Just to make this tangible, uh, in the past I've talked to, uh, Triple Point Capital, Hercules Capital, Golub Capital, who did our debt at Planful, uh, and Monroe Capital, who I've done some work with. These are the types of firms that provide venture debt. Some of these firms also provide private credit, um, to back acquisitions. You have any you want to talk about, Ray?

Yeah, you know, um, I've worked as a consultant for 2 PE firms, and one of the things I was surprised at was, you know, PE buyers like Francisco Partners, um, and I worked with them back in the early 2000s, Vista, and even Thomas Bravo, they have their own private credit arms for their deals. And I'm kind of like, it's almost like circular financing in my mind. Hey, if you're buying the firm, you're maybe using 50% equity to also basically hedge your equity investment by being the private credit lender also. Didn't seem quite right, but I do understand the attraction.

So, 2 things. One, it's Thoma Bravo. There is no Thomas Bravo. You've invented a new person. So, it's Thoma Bravo. And second, do they have their own arms? I mean, the answer is yes. I received a deal from TPG that had what's called dequity, that had both an equity offering and a debt offering, and they were tied together. Is it a good idea? I don't know. I'm not going to judge. If I'm one of those firms, it makes sense to me to want to do it because it's like, why are these debt providers getting these great interest rates? Basically, you know, the first law of finance, jealousy. Like, hey, these guys on our companies are earning a high rate of interest and they're diluting our equity 'cause they're taking a percent or 2 and maybe more if they're doing a big buyout backing. 'Cause my percentages were for venture debt, not for PE-backed. So they may have an even bigger slug of the equity. Why don't we just do that ourselves? We know people with money. Why don't we create our own funds where we seek LPs looking to do venture debt or direct private lending? And we'll go build those funds ourselves and get the fees. So I think it's probably a good idea, but like all things, you know, what's the expression? The only thing that goes up in a downturn is the correlation between asset classes, right? And so like, I think both sides will tend to go bust at once. Although in this particular case, by the way, as we'll get to the Medallia case in the instance, it was not backed by a private equity firm's private debt line.

Right.

But if it had been, those guys would've got their money back, at least part of it, whereas the equity guys didn't get anything.

By the way, they would've gotten some of their debt paid off and the ability to transition that debt into equity again.

Yeah, they would've owned the company, right? So had it been done in the case we're gonna study today, which is Medallia, it wouldn't have been that— it would've been better than they ended up, 'cause right now they ended up with nothing. And in this case, they would've ended up owning the company, which they already did, or not owning the company, right? Not losing the company. And they would have had some of their debt come back. So maybe not such a bad idea after all.

Absolutely.

Let's talk about how this is typically used. So we've already talked about the first use case, which is the classic venture debt use case, which is you just raised a round of $20 million. And if you don't know this, that's a great time to raise debt. Why? Because people like to loan money to people who don't need it, right? So if you just have, I'm gonna say $50 million, sorry to switch the number, sitting in the bank from your fresh equity round, Why not go borrow $10 million? Because all the venture debt people will be more than happy to give you $10 million when you just raised $50 million. And that will include, basically increase your runway, limit your dilution. So that's the classic use case of venture debt.

Yeah, it really improves the, whether you call it blended cost of capital or weighted cost of capital, it improves it. And in my experience, Dave, that relationship was between the VC and the venture debt lender. So the time, 2 times that I've done it, it was basically the VC actually introduced me to the venture debt lender and said, hey, you should go out and get some credit from this particular lender.

Yeah. And that's smart to listen to the VC in that case, Ray. I have 2 rules of venture debt. The first is you want your CFO to be the reference case study on the debt provider's homepage. And it may sound funny, but I want that because if things go bad, these people have the power to potentially bankrupt your company, right? Because these loans, as we'll talk about, have covenants. If you're in violation of a covenant, the debt provider now has a discretionary decision to make about what to do about it. And if they don't know you and aren't afraid of you, the easiest thing to do is just go bankrupt you and take what they can get. But if they do 20 other deals per year with your venture investors, and they know all that business is never going to happen anymore if they bankrupt one of their companies, right? They're going to be a lot less likely to do that. And silly enough, they're also going to be less likely to do it if you're sitting there on their homepage. If your CEO is the guy on the homepage going, we love Gollum, Gollum is going to have to think twice about taking your company and basically putting it into receivership. So, those 2 reasons, right? You want to be a visible reference who they know and like. And more importantly, you want them to say, wait a minute, if I do a bad thing to this company, I'm never going to work with this VC firm again. So, your VC was smart in that case, Ray, to recommend that firm.

In fact, my VC told me, Ray, this is called relationship capital that you have access to. Our relationship, their capital.

Oh, that's funny. That's funny. I like that. So that was the first use case of kind of private credit with startups, venture debt. The second use case, and the one we're going to drill into today, is basically leveraged buyouts, where a PE firm comes along and wants to buy a company. Let's just say for the sake of example, they want to pay 4x ARR for that company. Let's make it concrete. We'll pretend ARR is $50 million. So they want to pay $200 million for that company. And they can either just write a check for $200 million, Or if they want to leverage their returns, they could actually go to a debt provider and say, hey, could we borrow $100 million? So let us borrow 2x ARR and we're going to buy this thing for 4x ARR. And basically in effect, that doubles our returns, right? If we just pretend the debt has no cost, I've bought the whole company for $100 million of equity, right? $100 million check that I had to write versus a $200 million check.

Wow.

which has the effect of doubling my IRR. Now, of course, that debt does have a cost, so it doesn't quite do that. But this notion of leverage is very important to— it's the L in leveraged buyouts, right? And it's the way you juice more out of the return is you don't write a $200 million check for a $200 million company. You write a $100 million check for a $200 million company.

Well, leverage is the engine of private equity deal returns. But it also works in reverse, Dave, because, right, if that business deteriorates to 2x ARR, the lenders are still whole for the most part on their $2 of debt. So, because equity can be impaired. So there's 2 edges to that sword, huh?

Yeah, leverage is a double-edged sword. There's no question. No question that, I mean, they're leveraged and leverage, the lever goes both ways. In good times, it doubles your returns. And basically in bad times, it cuts them in half. And by the way, to Ray's point, it can very quickly cut them to zero. Because if the company's worth less than the loan balance, then the— and you sell it, the only person getting paid is the debt holders, not the equity holders. So—

Hey Dave, let's dig into some of the structure and terms of these private credit deals.

Yeah, so a private credit deal is typically a 3 to 5 year term loan with 1 to 2 years of interest-only payments followed by either amortization over the remaining 3 or so years, Or what's called a bullet, which is it's interest only for the entire loan duration. And at year 5, the whole thing is due. And I like calling it a bullet because if you're running that SaaS company that has a $100 million loan, at the end of year 5, the odds of you being able to repay that loan are like zero, right? So you either need to sell the company before that $100 million payment becomes due, or you need to refinance the loan, hence the term.

Bullet. I never heard bullet before, right?

Oh yeah, that's a good common term.

Um, but I do know this is also where the PIK, kind of the payment in kind, interest shows up, right? Yeah.

So another thing about these loans is that there's often payment in— a PIK, as they call it in the business. And a PIK stands for payment in kind, as Ray said. And that means instead of paying cash to pay off the loan. You pay in kind, meaning you just increase the loan balance. So $100 million loan at 10% interest, if you want to do a PIK structure, at the end of year 1 simply becomes a $110 million loan. So the loan is compounding underneath you. It's good for cash flow. It's obviously bad for the loan balance. And eventually when either the payment comes due or when interest payments become due, you're going to be paying interest on a lot more money.

Yeah, I call this kicking the tin can down the road, right? And I'll just put a real example of this, right? If you have a $100 million kind of picking loan at 10% annually, right, after 2 years you have a $121 million loan, and after 3 you have a $133 million loan. And if your EBITDA and free cash flow is not growing proportionally, you're going to have some challenges with your interest coverage ratio.

Correct. A lot of these things, bullets are dangerous, picks are dangerous. They all work well if things go well. If you can refinance and kick the can, I've never heard kick the tin can, Ray. That's awful specific. If you can kick the tin, aluminum, or stainless steel can down the road, that's normally what people do. I believe that in the banking speak, that's called amend and extend. But it's the basic idea of, oh, before the pick, before the loan becomes due with the pink interest and the now included in the balance, We'll refinance this and kick it down the road for another 5 years. Now, another part of these loans, as we talked about already, is warrants. Again, it's typically 5 to 15% of the loan amount, which ends up equating to around half a percent to up to 2% of the company's shares, depending on how big the loan is relative to the company value and how big the round was. The other thing these loans include are covenants, and they are what I call the third rail. What is a covenant? It's a promise, just like in the Bible. It's a promise to maintain certain things. It could be liquidity. We promise to keep $2 million cash in the bank. It could be free cash flow. We promise to keep twice as much free cash flow as interest. It could be net leverage. We promise not to get this much more debt on the books. It could be bookings, which I do not, do not, do not like. A bookings covenant is bad. I mean, just ask any operator how often you miss bookings, and the answer is frequently. And by the way, you can miss bookings and cut expenses and still be just fine on free cash flow. So Dave Kellogg is not in favor of bookings covenants because I think covenants should primarily be about, can I repay you? And bookings are my problem. If I miss my bookings number and fire 10 people to make sure I have good free cash flow, You know, you can worry about free cash flow or EBITDA. Those are fine things to worry about. You can worry about my ARR balance because people increasingly use ARR as collateral. So if my ARR is shrinking because I'm churning stuff out, okay, that would be reasonable. But I really dislike bookings covenants because, by the way, let me be clear. When you trip a covenant, they typically have the right to call the loan. Now, they won't typically see prior discussion about relationships with VCs and their reputation. but they can put you out of business and just say, I'd like my $100 million right now. And I have worked with companies where the lenders did that, right? So that's why I call 'em the third rail, right? You touch it and you die. If you're not familiar with the metaphor, it's the electric rail on the subway system. So covenants are a big, big deal, Ray, thoughts?

A really big deal. And if you're not in the room where these conversations are happening, sometimes you wonder why is the private equity firm so focused on 30% EBITDA? Or 35% EBITDA. And often I find that happening because growth's not quite as high as it was, and they wanted to make sure they were still safe from an interest coverage ratio and not tripping one of those covenants. I don't know if you've seen that, Dave, but that's one of the reasons I see EBITDA as such a focus. Yeah.

So, so I'm going to go up a level, Ray. The— you're making one point indirectly that whatever your covenant is, if it's EBITDA, bookings, ARR, It should be in your company dashboard. In my mind, the last line of your company dashboard for every proposed financial plan, every forecast, every board update, there should be one slide that summarizes the company's financials. And the last line should be covenants passed, yes, no, red, green. So, when we're looking at a proposed financial plan, if we're required to maintain a ratio for something of 2 to 1, I want that ratio calculated, put in a cell, And if this forecast has it coming in at 1.7, I want that in red and I want it on page 1. Because as my daughter goes to HBS, Ray, as you know, and I went to a class with her once and there was a case study on a private equity-backed flower company. And in a footnote, they mentioned the loan covenants and you're not allowed to talk because parents can go to class with their kids, but you can't talk when you're there. And I'm literally like sitting in my seat trying to go, there's a covenant, there's a covenant. Look at the covenant. And as the professor said, eventually when the kids figured it out, he goes, covenants are existential, which is the right way to say it. And that's why they belong on page 1 of your dashboard. Ray, are we ready to go to Medallia now as we wrap this thing up with a case study?

Let's hit it.

All right. So Medallia, Ray and I are going to do this one interactively. Thoma Bravo acquired Medallia in 2021 for roughly $6.4 billion at about 9x revenue, which by historical standards is high. For the time, it was actually a good deal. I think it was either at or below the median SaaS company revenue multiple. So nevertheless, though, in my mind, 9x revenue is expensive. The deal included roughly $1.8 billion of debt and $5 billion of equity, right? So they didn't do the kind of 50/50 split I was doing. I'm going to say more, it's hard to do the math, but a 5 to 2 split, let's just say, of equity to debt. So they kind of sweetened their returns Rather than writing a $7 billion check, they wrote a one—they wrote a $5 billion check and borrowed 1.8, right? To kind of juice their returns. Let's just call it 20%, maybe 40%, actually. But anyway, somewhere in there. Now, about 33% debt. So they're juicing their returns by that. Now, it was a $1.8 billion loan backed by Blackstone, Apollo, KKR, and Antares. So, and it was predicated. On continued growth and margin expansion. Basically, the idea here was that while Tomo Bravo— Tomo, I got me doing it now— Tomo Bravo assumed the growth would happen so they could turn the company to having, say, 25% free cash flow margins, which would have covered the debt. Had the company kept growing, had they been able to improve the margins to like 25%, everything arguably would have been fine. But a couple of things went wrong. One, the underlying rate went up, right? So LIBOR and SOFR went up from like 0.75% to like 5.4%, and now it's down today around 4%. And they had a PIK, and all the interest in year 1 was on the PIK, half the interest at the end in year 2 was on the PIK, and then 35% for the next couple of years on PIK. So their balance kept growing, and their debt kept getting bigger to the point where that $1 billion loan with the benefit of the picks turned into a $2.2 billion loan now at a higher rate. And all the time the business is in trouble. And basically what happened was the wheels came off pretty quickly. Do you wanna walk us through some of the numbers of the wheel detachment process, Ray?

Well, yeah, I mean, high-level numbers, they had about $200 million of EBITDA. And now because of the pick kicking in, they had $300 million of interest payment. So the math simply stopped working, right? I mean, this interest coverage ratio fell below 1x. So the business was effectively now just working for the lender to pay off the debt. And one of the things, and I know we're not going to double-click on this too much, but the lenders had been marking down the value of the debt for months. And in fact, I think in March, Blackstone marked it all the way down to $0.60 on the dollar, which is high stress, right?

Yeah. So, so obviously Blackstone knew there was a problem happening. So usually these marks are done Slowly, I'd say the marks are sticky on the way down because there's not a free market for this debt. People aren't buying and selling this debt. This is not a market signal. This is a debt owner providing marks to its its investors, and those tend to be sticky on the way down. I mean, overall, what happened was at some point, hey, we got to pay $300 million in interest a year. We're only generating $200 million in cash flow. Does anybody want to restructure the loan for us? No. Can we sell the company? No. Okay. What is— is there a third door? Can we raise a financing round? Usually people don't like to raise financing rounds just to pay off debt, right? Terrible. Like one of the worst uses of capital for a financing round is debt repayment. What investor wants to do that? So eventually, basically, Thoma Bravo handed the keys to the banks, to the lenders, and not banks, but to the lenders, the private credit lenders, and said, Hey, it's your company now, meaning they lost 100% of their $5 billion investment. This is a massive loss. And this is what happens when, when basically when you pay too much for a company, when its business doesn't perform as well as you hoped, when you can't get the margins up and you're carrying a lot of debt with a pick on top of it. And all of a sudden you could end up basically upside down where the company, when valued on a free cash flow basis, is worth less than the debt. And that's when you know you're cooked. Because I think if you, if you wanted to sell the company for what, 15 times free cash flow, you might be able to sell it for $3 billion. But, you know, $3 billion can't even pay off the loan.

So, and Dave, I don't— yep, I don't hear many people using this term anymore, but one other key variable that I didn't hear you mention there was This was done during the era of ZIRP, right? And when those rates, 'cause you mentioned they went up a lot of points, that was the death knell to me.

Yeah, you could call this the revenge of ZIRP. So ultimately, look, there are a lot of other companies out there. Look, Thoma Bravo did the standard PE playbook, which is to buy a software company for prevailing multiples, borrow some money to do it, improve free cash flow to pay off the loan, Then go sell it by the amount you grew it. And you could make a reliable living doing that. People started to say, oh, Vista, Tama Bravo, they're going to take over the world because this reliable playbook. And the problem is in tech, when anything gets too formulaic, I think Rory O'Driscoll said something, as soon as it becomes a playbook, the play is probably over, right? And that's what's kind of happened here. The world has changed. Money is more expensive. SaaS businesses are in trouble due to AI.

Right.

And now you still have all this debt on a company and, you know, you run out of options really quickly because no one wants to kick the can down the road. No one wants to finance you. If nobody wants to buy you, then you're stuck with potentially having to give the keys to the bank, as they say. And that's what happened in this case.

And Dave, I just want to highlight one more number between 2015 and 2025. 1,900 companies were acquired by PE. So to me, that tells me why the private credit risk is being talked about and could be really large for SaaS companies.

Okay, well, that's it for today's episode, everybody. I want to thank you for joining us. Any final words, Ray?

No, I think it was a really good episode and I'm glad we did it.

All right. Same here. Take care. The Metrics Brothers AI, SaaS, and More is a production of The Metrics Brothers Growth and CAC and a member of the Benchmarket Podcast Network. By accessing this podcast, you acknowledge that the Metrics Brothers make no warranty, guarantee, or representation as to the accuracy or sufficiency of the information provided or the humor content of the jokes told. Ray? Information, opinions, and recommendations presented are, according to our spouses, probably wrong and provided for information purposes only. This podcast should not be considered professional or, for that matter, unprofessional advice. We disclaim any and all liability for any direct, indirect, indirect, misdirect, incidental, special, ordinary consequences consequential, inconsequential, or other damages arising out of any use of, or God help you, reliance upon the information presented here. Ray Grothreich is based in New York City and available on X @rayreich. Dave Kellogg is based in Silicon Valley and available on X @kelblog. Schedectady, which is French for unspellable, is not our actual production location. Thanks for listening.