Private Credit Charges Less for Its Riskiest Software Loans

What's New

PRISM's Velcro Score analysis reveals that the private credit market has inverted the risk premium on software lending. The Velcro Score is a three axis taxonomy that classifies software borrowers by how difficult they are for customers to replace in a downturn, producing four credit archetypes from Utility Software (hardest to rip out) to Discretionary Tool (easiest). The finding: Discretionary Tools — the most substitutable, most cycle exposed category — price at an average total rate of 8.15%, while Utility Software, the category with near zero churn and budget inelastic demand, prices at 8.17%. The market is paying lenders less to hold the riskiest software credits than the safest.

Why It Matters

In any functioning credit market, riskier assets should command wider spreads to compensate for higher expected losses. The 2 basis point inversion across software archetypes signals that the market lacks a classification system capable of distinguishing between fundamentally different credit risks. Lenders are underpricing substitution risk, cycle exposure, and AI displacement vulnerability because the labels they rely on treat all recurring revenue software as one asset class.

Big Picture Drivers

• The Squarespace vs. One Inc paradox: Squarespace, a Discretionary Tool website builder (S4/I4/U4), carries a 7.04% total rate. One Inc, a Utility Software insurance payments platform (S1/I1/U1), carries 6.42%. The infrastructure layer credit earns a lower rate because the market recognizes its quality — but at the archetype level, that logic inverts entirely, with the average Discretionary Tool pricing tighter than the average Utility credit.

• Growth Dependent is the only archetype earning a premium: At 9.35% average total rate, Growth Dependent software is the only category where lenders are compensated for incremental risk, likely because ARR linked leverage tests make the risk more visible in documentation.

• Operational Backbone prices rationally: At 9.00%, Operational Backbone software sits appropriately between Utility and Growth Dependent, reflecting its high switching costs with mild cyclicality profile.

• GICS enables the mispricing: Because every software company carries the same sector label, there is no systematic mechanism to flag when a fund is accumulating Discretionary exposure at Utility pricing.

• Relative value is hiding in plain sight: High Velcro credits are cheap on a risk adjusted basis and low Velcro credits are expensive — an opportunity for lenders with the taxonomy to see it.

By The Numbers

• Negative 2 bps the spread inversion between Discretionary Tools (8.15%) and Utility Software (8.17%), defying fundamental credit logic.

• 113 bps the gap between Squarespace's 7.04% rate and the 8.17% Utility Software average, meaning a point solution website builder prices tighter than the average infrastructure layer credit.

• 9.35% average total rate on Growth Dependent software, the only archetype where the market prices incremental risk appropriately.

• 160 bps the interquartile range across all software positions (8.22% to 9.82%), remarkably narrow for a sector with four distinct risk profiles.

• 120 bps the premium Growth Dependent credits earn over Discretionary Tools, suggesting the market recognizes some risk differentiation but applies it inconsistently.

Key Trends to Watch

• Repricing catalyst: The approaching $467 billion maturity wall will force refinancing conversations where archetype level risk becomes visible, creating the conditions for spread correction.

• ARR lag trap: Discretionary Tools exhibit a 6 to 12 month lag between economic deterioration and ARR deterioration, meaning trailing metrics will mask credit problems until liquidity cushions are depleted.

• AI as spread widener: AI powered alternatives at lower price points will accelerate substitution risk for Discretionary Tools, making the current tight pricing even more anomalous.

• First mover advantage: Lenders who adopt archetype level pricing frameworks now can capture relative value in Utility and Operational Backbone credits before the broader market corrects the inversion.

The Wrap

The inverted software risk premium is not a curiosity — it is a market structure failure driven by classification systems that cannot distinguish between a core banking platform and a website builder. Lenders collecting 8.15% on Discretionary Tools while Utility Software pays 8.17% are being compensated for convenience, not risk. The correction will come, and the only question is whether it arrives through repricing or through losses.