Technology, Media & Healthcare

How to Underwrite a Software or Technology Company

Underwrite a software or technology company by splitting revenue into recurring subscription, maintenance, license, and services streams, then valuing each on its own retention and margin profile. The metrics that matter most are recurring revenue share, gross revenue retention, gross margin by stream, and EBITDA after treating capitalized development costs as a real expense.

What makes technology / software company underwriting different

Most technology companies that reach a lender or buyer are hybrids: some recurring subscription or maintenance revenue, some perpetual license or hardware sales, and a professional services arm that implements or customizes the product. Value comes from the recurring stream, switching costs created by embedded workflows and data, and the fact that incremental software revenue carries little marginal cost. Risk comes from technical debt, a product that depends on a few engineers, customer churn hidden in aggregate numbers, and revenue recognition choices that move income between periods. Services-heavy companies behave more like consulting firms and should not be valued like pure software.

Lenders focus on recurring revenue quality and cash conversion. Traditional cash flow lenders size debt off EBITDA, while recurring revenue lenders will lend against ARR for companies that are not yet profitable, provided retention is strong. Both look closely at capitalized software development, deferred revenue and customer concentration. Equity investors underwrite growth efficiency, product roadmap, market position and the potential to migrate legacy license customers to subscription. They accept near-term losses for durable growth, but they discount revenue that churns or depends on custom work.

Key metrics

Recurring revenue share

Subscription and maintenance revenue renews with little selling effort, while license and services revenue must be resold every period.

Buyers typically apply higher multiples as recurring revenue becomes the clear majority of the mix.

Gross revenue retention

Shows how much recurring revenue the company keeps before upsell, isolating churn and downgrades.

Lenders commonly look for gross retention around 90 percent or better in recurring revenue loans.

Gross margin by revenue stream

Software margins are high while services margins are much lower. Blended margin can mask a shift toward services.

Capitalized software development

Capitalizing engineering salaries raises reported EBITDA without changing cash spend.

Underwriters often add capitalized development back into operating expense when assessing cash EBITDA.

Deferred revenue and billing terms

Annual upfront billing funds operations, and changes to billing terms can shift cash flow materially.

Customer concentration

Enterprise-focused companies can depend on a handful of large contracts with renewal events inside the loan term.

How to underwrite it, step by step

Classify revenue into subscription, maintenance, license, hardware and services, and reconcile to contracts and revenue recognition policy.
Build customer-level cohorts to calculate gross and net retention by year and segment.
Calculate gross margin by stream, allocating hosting, support and services labor appropriately.
Adjust EBITDA for capitalized development, deferred revenue changes and one-time license deals.
Run technical diligence on code quality, architecture, security, open source licenses and key engineer dependence.
Confirm IP ownership through employee and contractor invention assignment agreements.
Review the largest customer contracts for renewal dates, termination rights and change of control clauses.
Size debt either on EBITDA or recurring revenue depending on profitability, and stress test churn and growth.

Due diligence checklist

Customer-level revenue file by month with product and contract detail
Revenue recognition policy and ASC 606 analysis
Master subscription, license and services agreements for top customers
Deferred revenue rollforward
Capitalized software development schedule
Hosting and third-party software cost detail
Technical diligence report and architecture documentation
Open source software scan and license inventory
Employee and contractor IP assignment agreements
Security assessments, penetration tests and SOC 2 reports
Sales pipeline and bookings history

Key risks and mitigants

Services revenue presented as recurring

Classify revenue at the contract level and value services on services multiples and margins.

Hidden churn in legacy products

Build cohort analysis by product line and size debt on retained revenue rather than gross bookings.

Key engineer or founder dependence

Assess code documentation and team depth, and use retention packages or key person provisions.

Open source license or IP ownership defects

Run a code scan, confirm assignment agreements, and require remediation or specific indemnities before close.

Security breach or data exposure

Review security controls and incident history, confirm cyber insurance, and include breach reporting in covenants.

Typical financing and deal structure

Profitable software companies are typically financed with senior term loans or unitranche facilities sized on EBITDA, sometimes with a revolver for working capital. Companies with strong recurring revenue but limited profitability use recurring revenue loans sized as a multiple of ARR, with covenants tied to minimum liquidity and recurring revenue or retention rather than leverage, often converting to EBITDA covenants later. Earlier-stage companies use venture debt with warrants. Smaller software businesses often rely on SBA 7(a) loans with a seller note. Acquisitions frequently include earnouts tied to ARR or revenue targets and rollover equity for founders. Representation and warranty insurance is common, with specific attention to IP and data privacy representations.

Red flags

Recurring revenue that turns out to be multi-year license deals recognized upfront
Capitalized development that grew much faster than headcount or product releases
Gross retention falling year over year while reported growth relies on new logos
Missing invention assignments from founders or offshore contractors who wrote core code
Top customer contract up for renewal within a year with a change of control termination right

Frequently asked questions

How are software companies valued?

Profitable software companies are usually valued on a multiple of EBITDA, while high-growth companies are often valued on a multiple of recurring revenue. The multiple depends on growth, retention, gross margin and the share of revenue that is truly recurring. Services and one-time license revenue are typically valued at lower multiples than subscription revenue.

Can you get a loan for a software company with no EBITDA?

Yes, through recurring revenue loans or venture debt. Recurring revenue lenders size loans as a multiple of annual recurring revenue when retention and growth are strong, and they rely on minimum liquidity covenants rather than EBITDA tests. These loans carry higher pricing and often include warrants or prepayment protections.

Why do underwriters adjust for capitalized software costs?

Accounting rules allow some engineering costs to be capitalized rather than expensed, which increases reported EBITDA. The cash still leaves the business every period. Underwriters often treat capitalized development as an operating expense when measuring cash flow available for debt service, which can significantly reduce EBITDA for development-heavy companies.

What does technical due diligence cover?

Technical diligence reviews code quality, architecture, scalability, security practices, technical debt, open source usage and team structure. It identifies risks such as reliance on outdated frameworks, single points of failure in the engineering team and licensing conflicts. Findings feed into the investment model as remediation costs or into the purchase agreement as specific indemnities.

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Educational content, not investment, credit, legal or tax advice. Benchmarks are common practitioner rules of thumb and vary by lender, market and cycle.