Private Eye: Madison Capital sets goal of doubling size of tech portfolio

September 2, 2016 By David M. Toll

Madison Capital’s recent push into technology lending is bearing fruit. The Chicago mid-market lender, which in the first quarter formalized and beefed up what had been an ad hoc approach to technology, has racked up six tech platform deals so far this year, with two more expected to close by the end of October and as many as four more beyond that by year–end, said David Kulakofsky, a managing director who leads new–business origination for the firm’s five-member tech team. That would mark a rise from its recent pace of four to six tech platform deals per year.

Along with insurance and financial services, and healthcare, software and technology services is among the fastest–growing segments of Madison Capital’s loan portfolio, according to Kulakofsky. The firm defines the sector to include software–as–a-service, healthcare IT, financial technology, hosting services, database services and related markets. The firm, with $8.25 billion in assets under management as of June, has set a goal of doubling its technology AUM to $1.6 billion over the next three to four years.

It is easy to see why tech is an attractive market for Madison Capital. The industry has matured to the point where many technology companies boast not just healthy growth rates but ample EBITDA margins, high customer–retention rates, and tall barriers to achieving scale. The often mission-critical nature of their services — database hosting and maintenance, for example — means tech companies can thrive even during recessions, as many in Madison Capital’s portfolio did during the 2009 downturn, according to Kulakofsky.

Altogether, more than 100 U.S. buyout shops, both specialists and generalists, now have a “significant appetite” for technology deals, Kulakofsky said. The high-tech sector accounted for 120 deals by U.S. sponsor-backed in the first half, the most of any sector, according to Thomson Reuters. Last year saw U.S. buyout shops sponsor 278 high–tech deals, down from 318 in 2014 but up from 228 in 2013 and 242 in 2012.

Risks for lenders are on the rise as well. Competition among lenders — the firm counts CapitalSource, Golub Capital, Silicon Valley Bank and Wells Fargo as rivals — has contributed to leverage multiples rising to 7x EBITDA in many deals, Kulakofsky said. And in the rules-don’t–apply–here tech market, players don’t necessarily follow the conservative practice of basing multiples on trailing–12–month cash flows; instead, they use run rates, or annualized cash flow based on performance during just the past few months.

Such dynamics don’t leave a big margin for error for loss-averse senior lenders. Then again, competition for deals has pushed price multiples into the teens for tech companies generating more than $20 million in EBITDA, according to Kulakofsky. Even in a distressed situation, lenders might expect to come out whole through a sale of a company with sufficient recurring revenue or valuable intellectual property to attract buyers.

Formalized Effort

Madison Capital, which celebrated its 15th anniversary this year, gets the majority of its funding from New York Life, a source that has sustained its lending operations in both good times and bad. (Even in 2009 the firm completed upwards of eight transactions.) The firm also manages more than $2 billion for third–party investors, including through four CLO funds, according to its website.

The lender prides itself on leading or co-leading nearly all its deals, typically involving cash–flow–based loans to sponsor-backed companies generating at least $3.5 million in EBITDA. Last year the firm formed a partnership with Carlyle GMS Finance to provide unitranche loans; it also started up a $150 million mezzanine finance program. The firm had plans to add six or seven net employees this year to bring its payroll close to 100.

To get its fair share of technology deals Madison Capital formalized its lending efforts in that sector in the first quarter. It tapped two veterans with tech experience to lead the way: Kulakofsky to head up relationship management and Vice President Brady Hahn to run the underwriting team. It also early this summer hired a senior underwriter for the five-person team.

The team now has the resources to do two things it hadn’t done before, Kulakofsky said. One is to call the tech specialists at generalist firms with which the firm already has longstanding lending relationships. The second is to expand coverage to include the growing population of tech-focused firms.

Kulakofsky and Brady, who both plan to spend more time on the West Coast drumming up deal flow, declined to comment on any specific deals spawned by these amped–up efforts. But according to a press release Madison Capital in early July teamed up with Carlyle GMS Finance to bankroll the recap of Global Software Inc by Thompson Street Capital Partners.

The facility included both a revolving credit line and a senior secured term loan for the provider of automation and reporting software. In its latest 10Q filing, Carlyle GMS Finance described its own “first-lien&rsdquo; loan to Global Software (not including the Madison Capital loan) as having a principal amount of $16.3 million, interest rate of 6.5 percent, and maturity date of May 2, 2022.

Carlyle GMS Finance evidently feels strongly about the company’s prospects. Along with its loan, the firm also made a $1 million equity investment — one of only four such investments on its balance sheet.