Before the Loss Becomes Visible

Software credit is an operating exposure. Founders and senior operators should understand what that means before the term sheet is signed.

On the morning of May 12, I was in San Francisco for a board meeting when The Wall Street Journal was delivered to my room. Inside was an article from Matt Wirz reporting that KKR Capital Corp. had taken a roughly $560 million loss in the first quarter.

I was captivated. It was a pattern I had been watching for years; this slow softening and repricing of assets as new technologies emerged and disrupted old assumptions. It also brought me back to the intense transaction environment of 2020 to 2022, when capital was abundant, and assets were often valued on conditions that were already beginning to shift. Many of those strategies had been built for a world that was quietly changing underneath them.

The loss was roughly 10% of the company’s net asset value. Loans in default had increased from 5.5% of the portfolio at the end of December to 8.1% by the end of March. Medallia, the customer-experience software company, was among the larger loans that had fallen into default.

Throughout my career, I have sat in boardrooms where a software company was trading materially below its peers, below the value the capital structure assumed, or simply below what everyone thought the business would become. By the time the valuation gap was undeniable, the causes were usually not new. The product had become less relevant. The company had become slower. Customers were less convinced. Capital had moved toward protecting near-term results while the thing creating those results was receiving less attention; the valuation was simply the point when everyone could finally see it.

I opened a notebook and started writing about the difference between owning an asset and producing its appreciation. We tend to talk about appreciation as though it comes with the asset. Capital goes in, time passes, and the value is expected to rise, yet the consistently proven truth is that a software asset does not appreciate passively; I would go as far as to say it’s actively depreciating- more on that later.

The only real way an organizational asset appreciates is when the product keeps getting better, customers keep choosing it, the organization stays coordinated, and capital continues going toward the work that keeps the company relevant. When those things start to weaken, the business may still make its interest payments for a while. It may still report recurring revenue. It may even continue growing. But the basis of the value can already be deteriorating.

That was what I saw in the article. The loan could still produce income while the company underneath it became less valuable. The lender could remain senior in the capital structure while the product became less important, delivery became more expensive, customers became harder to retain, or the company lost the ability to keep up with the market.

A financial instrument can be held passively. The source of repayment still has to be operated.

For any operator thinking about institutional capital, this matters before the term sheet is signed. Debt and equity are obviously different. The documents are different. The economics are different. The rights are different. But both are relying on the same company to keep creating value after the capital arrives.

The institution is not only backing the company you built. It is backing the company you say you can continue building.

KKR is a publicly traded business development company, not a stand-in for every private-credit fund or every lender. Its public reporting is still useful because it gives us a view into what can happen after the original underwriting is finished. In March, KKR held a $12.3 billion portfolio across 236 companies, with 63.7% invested in senior-secured securities. It generated $117 million of net investment income during the quarter and recorded $558 million of net realized and unrealized losses. Net asset value fell from $20.89 to $18.83 per share, while investments on non-accrual rose to 8.1% of the portfolio at cost, which indicates the portfolio was producing income and losing value at the same time.

That only feels contradictory if an interest payment is treated as evidence that the company underneath the obligation is healthy. I have operated inside a company that made more than $60 million in interest payments while the organization itself was unstable. The structure was suffocating and deeply unproductive. It tells us the borrower can meet an obligation today. It tells us much less about whether the company is protecting the product, people, customers, and decision-making ability it will need three years from now.

Seniority tells you who gets paid first. It cannot preserve the value that will be there to pay anyone.

A company can look durable at close and be less durable two years later

On KKR’s first quarter earnings call, Daniel Pietrzak talked about investments made in 2021 that the firm believed were high-quality second-lien and junior-debt opportunities. Some of those investments went on to underperform.

The part I keep coming back to is that the belief may have been reasonable at the time.

Underwriting captures a company at a moment. The lender looks at revenue, margins, retention, the management team, the competitive position, and the equity below the debt. The numbers may support the investment. The company may actually be a good company. The deal closes, then management has to keep it that way.

This is one of the things founders, or organizational leaders, can miss after a successful financing. Closing feels like validation. A sophisticated institution has studied the business and decided to invest. That matters, but it does not mean the company has now become durable. It means the company made a convincing case based on the evidence available at that time.

The next quarter starts almost immediately, and somehow everything shifts.

A product release slips, so the company puts more money behind sales to protect the year. Services fills part of the gap left by the product. A discount keeps a renewal in place. A senior product or engineering leader leaves, and everyone convinces themselves it is a personnel issue rather than a signal. None of those decisions looks fatal on its own; usually they are not, but over several quarters, they can change what kind of company you have and where the revenue is really coming from.

I have seen this more than once. Many, many times, from different seats and in different seasons.

Recurring revenue can still look strong even as the reason to renew becomes weaker. Gross margins can look fine while implementation teams do more of the work the product was supposed to do. Bookings can grow while discounting increases and the product falls behind. A real competitive advantage can slowly become a capability the customer can find in several other places.

The original underwriting may have described the company correctly. Repayment and future equity value depend on the company management continues to build, which is why our underwriting begins with a more durable question: what has to remain true for this to stay a good business?

Capital also changes the environment in which the founder, or executive team, is operating. There may be an interest payment now. There may be a preferred return, a liquidation preference, new board rights, tighter reporting, or a growth plan the company has committed to. The company may have more money and less room to miss at the same time. That is not necessarily a bad thing; it just needs to be understood and discussed openly and frequently.

Software and technology companies are particularly unforgiving here because there may not be much tangible property to fall back on. The real value sits in the customers, the product, the data, the technical knowledge, the people who understand the system, and the company’s ability to keep improving it.

Federal Reserve researchers found that the post-default value of direct loans in their sample was about 34%, compared with roughly 52% for syndicated loans. They linked part of that difference to private credit’s exposure to industries such as software, financial services, and healthcare services, where there are fewer tangible assets to recover.

A first lien gives the lender priority. It does not make the product useful or keep the customers from leaving, thus eroding or degrading all tangible asset value; asset value becomes trading leverage in future periods.

Once you take institutional capital, the product and the capital structure start living together

Private credit has moved heavily into software. The Bank for International Settlements estimated that direct loans to SaaS companies grew from nearly $8 billion in 2015 to more than $500 billion by the end of 2025, or about 19% of all direct lending.

There are good reasons for that. Software can have recurring revenue, strong gross margins, low capital requirements, sticky customers, and sponsors with additional money. Those are real strengths, and they are also outputs of the business; they are not, permanent features of the company.

Recurring revenue has to be earned again and ideally expanded at renewal. Gross margin depends on how much labor and complexity it takes to deliver the product. The equity cushion depends on someone continuing to believe that the company deserves its valuation.

Founders and senior executives may think about product, finance, customers, and talent as separate areas of the business. Once institutional capital is involved, those decisions begin touching the capital relationship very quickly.

A delayed release can hurt retention. Retention can hurt the forecast. A missed forecast can reduce covenant headroom or weaken the board’s confidence. Once confidence starts to change, the operating team may have less freedom in deciding what happens next.

I am not saying that as an argument against institutional capital. Good capital can help a company do things it could not do alone. It can create room to invest, hire, acquire, or take a longer view. But the senior operators should know what kind of relationship is being entered.

The investor is, or in an ideal world should be, financing the company’s ability to keep making good decisions. When those decisions stop producing the expected results, the capital provider becomes more involved because its claim is now at risk.

Medallia is a useful example, one plucked right from my core field of experience, customer experience software and services. In June 2026, Medallia announced a recapitalization agreement that would significantly reduce its debt, transfer ownership from Thoma Bravo to an investor group led by Blackstone, Apollo, and FS KKR Capital Corp., and provide $150 million of new capital for product investment and AI transformation.

At that point, the lenders were no longer simply monitoring whether Medallia could make a payment. They were involved in ownership, capitalization, product investment, and what the company needed to become next.

That transition is worth noticing.

An operating team or founder can begin with a lender who appears to sit outside the operation. If the plan misses badly enough, that same lender may end up with rights over leadership, budget, strategy, or ownership. The operating issues do not suddenly become financial issues during the crisis. They were affecting the financial claim all along. Operators need to understand those rights and those paths before they become necessary.

A five-year loan can outlive the thing that made the company special

Artificial intelligence is making this conversation more urgent because it is changing what counts as differentiation in software.

Capabilities that once required a company to build a specialized product can increasingly be built into a larger platform or offered as a feature by someone else. What supported an entire product category a few years ago may now be one use case inside another company’s system. The BIS has identified the concentration of private credit in software as a growing concern as AI changes competitive conditions across the sector.

A July BIS follow-up estimated that business development companies alone had extended around $115 billion to software companies, approximately one-fifth of their total lending. The researchers did not find that the loans, or the equity prices of the BDCs holding them, had yet been priced differently according to software exposure. That distinction matters. An operating exposure can be present before the financial claim fully reflects it.

That does not mean every established software company is about to become obsolete. I do think founders, executive teams, and boards need to get more precise about why the company matters.

It is not enough anymore to say the product is differentiated today. What remains valuable if the most visible feature becomes common? How deeply is the product tied into the customer’s daily work, DAU anyone? What does the company know that a new entrant will not know? What would the customer actually have to unwind to leave? And does the organization have the ability to build the next reason for the customer to stay?

A feature may become common while the workflow around it remains difficult to replace. Proprietary data can still matter. Trust may matter more than novelty in a regulated or mission-critical environment. Customer history, integrations, switching costs, and implementation knowledge can all be durable. But operators should be careful not to keep describing the moat in language that was true three years ago.

I have watched companies do that. The market moves. Competitors catch up. Customer expectations rise. Building a similar capability becomes cheaper. Meanwhile, the company’s budget, valuation, and debt load continue to assume that the old advantage is still intact.

The duration matters. A five-year loan can still be outstanding after the capability it financed has become widely available.

That should affect how much money a company raises, how much of it is debt, how long the company commits to carrying it, and what assumptions are built into the plan. The question is not only whether the company has a moat. It is how quickly the moat can become a common use case and whether the organization can create the next advantage before that happens.

Operating executives should; must answer that privately before presenting the polished version to an investor.

The founder, the operating executives usually see the operating problem before the lender sees it in the numbers

Private credit is not passive in the everyday meaning of the word. Lenders negotiate covenants, receive financial information, talk with management and sponsors, and renegotiate loans when a company begins to struggle. Those relationships and the ability to work directly with a smaller lender group are part of the appeal of private credit.

My concern is less about whether lenders are paying attention. It is what the reporting is helping them see and understand without distortion. Leverage, liquidity, interest coverage, EBITDA, and recurring revenue all matter. But they usually show the financial effect of decisions made earlier. They are primarily lagging indicators.

I have watched software companies quietly trade product investment for bookings. It rarely feels reckless while it is happening. The forecast needs another quarter. Sales wants more flexibility. A release is late, so services steps in. Discounting helps save the renewal. R&D declines as a percentage of revenue while sales and distribution spending grows.

The numbers may hold for a while because the company is compensating for what has weakened.

Sales effort carries more of the result. Implementation teams perform work the product should perform. Discounts protect revenue that has become harder to earn. Eventually, the company is buying revenue that the product used to earn more naturally.

Operators must not wait for the board or lender to rebuild that story from a missed forecast. I would want to see renewal cohorts and discounting together. I would put roadmap delivery beside implementation hours and support issues. I would look at where the next dollar is going and whether product adoption, retention, gross margin, and the movement of key product and engineering people support that decision.

The point is not to build a much bigger dashboard. It is to see whether the financial result and the operating reality are beginning to tell different stories.

This is also where transparency matters. Founders and executives often experience transparency as something an investor demands. I think it can protect them and the institution as well because when management identifies a miss early, explains what caused it, and shows the choices available, the team is still leading the conversation. The board can help govern the actual company rather than react to a story that has already broken down.

When management protects the narrative until the results make the problem impossible to deny, the questions become larger. Did the team understand what was happening? Why was it not raised earlier? Can the board still trust management to fix it?

The operating miss is now also a credibility problem.

Good governance should make the expectations clear before any of this happens. What information is shared? How often? What kind of variance requires a conversation? Which decisions need consent? What happens when the company needs another year or more money?

Ambiguity can feel flexible when the deal closes. It feels much less flexible when the plan misses.

Operators should negotiate what happens when the plan does not work

Founders and senior operators naturally spend a lot of time on valuation, dilution, interest rate, maturity, covenants, and control. They should. Those terms are important; but the relationship will be tested by what happens when the company does not perform exactly as planned.

Before closing, I would want to understand how often the institution expects to review the business, which misses require a formal discussion, what rights become active during underperformance, and who gets to decide where the company cuts or continues investing.

What happens if revenue is 15% below plan? Does the company reduce product investment, sales spending, or margin expectations? Who makes that call? Is there more capital if the original plan needs another twelve months? Does the institution know how to support a product transition, or will its first instinct be to cut costs and protect the debt?

Those questions will tell a great deal about the actual relationship.

I would also want to know what the capital provider is good at. Some institutions understand credit extremely well but do not have much experience judging product health, technical debt, roadmap quality, or the capacity of the leadership team. Others present a large operating bench during diligence, but the help arrives only after trust has already fallen apart.

A good capital partner should be able to tell the difference between a fixable operating miss and a company that is losing its place in the market. Those situations need different answers.

Debt can sometimes look less intrusive than equity because the team is not giving up ownership on day one. But a company with high leverage and little covenant room may have less operating freedom than a company that sold more equity to a patient investor.

The cheapest capital on paper is not always the capital that leaves the company with the best chance to succeed.

The better question is whether the business can carry the structure while continuing to invest in its product, hold on to important people, absorb a bad quarter, and change the plan when something the company could not predict actually happens.

Operators must know what the capital will require from the organization and what will be cut first if the company falls short.

The loss shows up at the end

I do not read KKR’s first-quarter result as proof that private credit is broken or that AI will make software impossible to finance. The portfolio included different companies, different capital structures, and different operating problems. The vintage probably matters. Junior debt probably matters. Execution matters. Technological change may matter too. What the results affirmed to me is that software appreciation has to be produced.

We can underwrite the company, negotiate the documents, structure the claim, and establish the protections. After that, management still has to create the enterprise value that supports all of it.

I have been in enough boardrooms to know that a company usually does not begin declining on the day its valuation falls or its debt becomes impaired. The causes have often been accumulating for some time, years before they are visible: delayed product decisions, leadership gaps, customer changes, internal friction, and capital choices that seemed manageable one at a time.

The financial result makes those conditions visible to everyone who was not inside the company.

For a founder or executive operating team, institutional capital should be more than an endorsement, a bank balance, or a bridge to the next valuation. It creates obligations against the future work of the organization. It also gives another party rights that will matter more if the company begins to struggle.

At its best, that capital can give a team more time, better governance, useful partners, and the resources to build something the company could not have built alone; however, the structure has to leave enough room for the company to adapt, and the relationship has to be honest enough to deal with problems before the numbers become the only version of the truth anyone believes.

When I put the paper down that morning, the $560 million was the number everyone could see. The deterioration behind it had almost certainly started earlier. That earlier period, when the companies still had choices, and the relationships still had trust, is the part founders, senior operators, and capital providers should be designing for.

———

Capital should expand a company’s ability to keep making good decisions.

Idealists Only partners with founder-led software and tech-enabled businesses through minority and structured growth investments. For founders evaluating capital, or institutions looking for an operating and value-creation partner, begin a confidential conversation here.

This article reflects the author’s views and is provided for informational purposes only. It does not constitute investment, legal, tax, or accounting advice, nor an offer or solicitation to buy or sell any security. Public-company and market information is based on sources available as of July 30, 2026, and may change.