A recurring revenue loan is sized on ARR, but it is repaid from cash that the interest itself consumes, and the binding test is usually liquidity.
A recurring revenue loan is sized at the lesser of two numbers: a multiple of annual recurring revenue, and the debt whose interest the company's cash can carry for the runway the lender requires. On an illustrative software company with $60M of ARR, a 1.25x multiple allows $75.0M, but a 24-month runway at 10.50 per cent caps the loan at $57.1M, or 0.95x ARR. The liquidity test binds, not the multiple.
Worked in full in The Private Credit Investor by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Lending against ARR exists because many subscription businesses with sticky revenue are not yet profitable, so a leverage multiple of EBITDA has nothing to divide by. The lender substitutes a revenue multiple, a minimum liquidity covenant and a date on which the loan flips to a normal leverage covenant. Each of the three is a calculation, and the headline multiple is the least important of them.
| Input | Value |
|---|---|
| Annual recurring revenue (ARR) | $60.0M |
| Cash burn before interest, a year | $4.0M |
| EBITDA margin today (burn taken as negative EBITDA) | −6.7% |
| Cash on balance sheet after closing | $20.0M |
| Maximum loan, multiple of ARR | 1.25x |
| Rate: SOFR 4.00% + 650 bp | 10.50% |
| Required runway (burn plus interest) | 24 months |
| Covenant flip to leverage test | Year 3 at 6.0x |
| ARR growth a year | 20% |
ARR limit = ARR × multiple
Liquidity limit = (cash ÷ runway in years − annual burn) ÷ interest rate
Maximum loan = MIN(ARR limit, liquidity limit)
In Excel: =MIN(ARR*Mult,(Cash/Runway-Burn)/Rate)
Step 1: the ARR limit. 60.0 × 1.25 = $75.0M. Against an illustrative enterprise value of 6.0x ARR, $360M, that is a loan-to-value of 20.8 per cent, which looks very safe.
Step 2: test it against cash. At 10.50 per cent, $75.0M costs $7.875M of interest a year. Add $4.0M of burn and the company consumes $11.875M a year, so $20.0M of cash lasts 20.2 months. Over 24 months the need is $23.75M against $20.0M available. The loan fails the lender's own runway test.
Step 3: solve for the loan the runway allows. Over two years, $20.0M of cash gives $10.0M a year. Burn takes $4.0M, leaving $6.0M a year for interest. At 10.50 per cent, $6.0M of interest carries 6.0 ÷ 0.105 = $57.1M. That is 0.95x ARR, and an LTV of 15.9 per cent.
Step 4: check the flip. In year three the covenant becomes total leverage of 6.0x EBITDA. $57.1M needs $9.52M of EBITDA. ARR growing 20 per cent a year reaches $103.7M, so the required margin is 9.2 per cent, against minus 6.7 per cent today. Had the lender advanced the full $75.0M, the company would need $12.50M of EBITDA, a 12.1 per cent margin.
| Test | ARR limit loan | Runway-sized loan |
|---|---|---|
| Loan | 75.0 | 57.1 |
| Multiple of ARR | 1.25x | 0.95x |
| Annual interest | 7.875 | 6.00 |
| Runway, months | 20.2 | 24 |
| LTV at 6.0x ARR | 20.8% | 15.9% |
| EBITDA margin needed at the flip | 12.1% | 9.2% |
Because interest is paid out of the same cash that funds the burn, the rate is a sizing input, not just a pricing one.
| Runway | Rate 9.50% | Rate 10.50% | Rate 11.50% |
|---|---|---|---|
| 18 months | 75.0 | 75.0 | 75.0 |
| 24 months | 63.2 | 57.1 | 52.2 |
| 30 months | 42.1 | 38.1 | 34.8 |
At 24 months, each 100 basis points on the rate moves capacity by about $5M to $6M, close to a tenth of ARR. Lengthening the runway from 24 to 30 months removes a third of the loan. Adding $3.75M of cash, to $23.75M, restores the full $75.0M: each dollar of cash at closing buys about $4.8 of debt capacity.
| ARR growth a year | ARR in year 3, $M | Margin, $57.1M loan | Margin, $75.0M loan |
|---|---|---|---|
| 10% | 79.9 | 11.9% | 15.7% |
| 20% | 103.7 | 9.2% | 12.1% |
| 30% | 131.8 | 7.2% | 9.5% |
Growth and profitability trade off at the flip. A borrower that grows at 10 per cent instead of 20 must find nearly three more points of margin, and must do it while spending less on growth.
Retention sits behind every row of both tables. The ARR multiple assumes that the revenue renews; if gross retention falls, ARR stops growing towards the flip and the burn usually rises as the company spends to replace lost customers. That is why recurring revenue loans carry a retention or minimum ARR covenant alongside the liquidity test, and why the lender should run the flip at the low end of the growth range rather than the plan.
The common mistake is to treat the ARR multiple as the loan size and the LTV as the comfort. A 20.8 per cent LTV says nothing about whether the company can pay interest until it is profitable; a loan of $75.0M here runs the cash out roughly four months early. The second mistake is to underwrite the flip on today's interest rate and today's growth: if both move the wrong way, the margin needed rises at the same time as the ability to deliver it falls. The cash runway is the recurring revenue equivalent of the fixed charge coverage ratio, and it deserves the same stress testing.
Size an ARR loan as MIN(ARR × multiple, (cash ÷ runway − burn) ÷ rate), then check the margin the flip demands. On these illustrative figures the answer is $57.1M, 0.95x ARR, and it needs a 9.2 per cent EBITDA margin in three years. The free workbook for this case runs the conventional version of the same discipline: a lender's model stressed until a covenant breaks, with loan-to-value as a check rather than the answer.
A loan to a software or subscription business sized on annual recurring revenue rather than EBITDA, because the borrower is not yet profitable. Lenders rely on retention and liquidity covenants until the loan converts to a leverage covenant. In the illustrative case, $60M of ARR at 1.25x supports $75.0M before the liquidity test cuts it to $57.1M.
Because interest is paid from the same cash that funds the burn. With $20M of cash, $4M of burn and a 24-month runway, the company can spend $6.0M a year on interest. At 9.50 per cent that carries $63.2M of debt; at 11.50 per cent only $52.2M. Higher rates cut ARR loan capacity directly.
The date on which the recurring revenue covenant is replaced by a conventional leverage covenant. A $57.1M loan that must sit below 6.0x EBITDA in year three needs $9.52M of EBITDA. If ARR grows 20 per cent a year to $103.7M, that is a 9.2 per cent margin, from minus 6.7 per cent today.
This article is one calculation from The Private Credit Investor. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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