The surge in bad loans in the US software industry has led to a vicious "software-PE" death spiral, causing widespread financial instability and raising concerns about the future of the sector. This cycle involves software companies facing increasing debt burdens, which in turn force private equity firms to exit their investments at a loss, further depressing the market and leading to more defaults and layoffs. Experts warn that without intervention, this downward spiral could have long-lasting impacts on the broader technology ecosystem and the economy as a whole.

The U.S. software industry is facing a credit crisis triggered by artificial intelligence.

On Thursday, according to data compiled by Bloomberg, over $17.7 billion in tech company loans have fallen into distress over the past four weeks, with the total amount of distressed debt in the tech sector soaring to approximately $46.9 billion — the highest level since October 2022. This crisis, dubbed the “SaaS Apocalypse” by the market, is rapidly spreading from the stock market to the private credit sector.

The core driver of this sell-off is market concern over AI disrupting traditional software business models. The Software-as-a-Service (SaaS) industry is considered particularly vulnerable as AI begins to replace traditional software functions such as coding and data analysis.

The impact of this crisis is spreading, with distressed debt including loans to healthcare software company FinThrive and call center technology firm Calabrio, both supported by private equity firm Clearlake Capital.

U.S. bank analysts note that about 14% of leveraged loan market assets are exposed to the tech industry, with this figure reaching 20% in the private credit space. For collateralized loan obligations (CLOs) that bundle leveraged loans, the software sector accounts for between 11% and 16%. The private credit market is currently experiencing two shocks: the collapse of the logic behind software company loans and the waning attractiveness of private credit.

Software Industry Debt Rapidly Deteriorating

Bloomberg Intelligence data shows that $17.7 billion in tech company loans have fallen into distress over the past four weeks, mainly concentrated in the SaaS sector. Distressed loans are those with yields more than 10 percentage points above the benchmark SOFR (Secured Overnight Financing Rate).

Beyond the already distressed debt, more software company loans are approaching stress levels. Leveraged loans to HR management software provider Dayforce and call center technology firm Calabrio, both owned by private equity firms Thoma Bravo and others, are nearing distress. Loans to data integrity software company Precisely, jointly owned by Clearlake and TA Associates, fell 8 cents this week.

Jack Parker, portfolio manager at Brandywine Global Investment Management, describes the current situation as a “sell first, ask questions later” moment. He said, “It’s really painful for the industry — widespread selling of all assets in the sector, with little regard for how much AI could disrupt these businesses or how long it might take.”

U.S. bank analysts found that since January 9, 80% to 90% of issuers in the enterprise software and tech services sectors have experienced negative price returns. January 9 is called the ‘inflection point’ for the industry. The analysts wrote in a report: “As AI advances rapidly, there is increasing concern that AI could threaten software and service providers, and if not completely eliminate them, it could pressure their revenue streams.”

Private Credit Faces a Double Dilemma

The distress in the software industry is transmitting shockwaves to the private credit market. The stock prices of alternative lenders like Blue Owl, Runway Growth Finance, and Golub Capital have begun to plummet in tandem with the software sector.

Data from Ebrahim Poonawala’s team at U.S. bank shows that, using the tech category as a broad proxy, software appears to be one of the largest industry exposures for Business Development Companies (BDCs). Raymond James analyst Robert Dodd pointed out that actual exposure might be even higher, as loans to software companies are often classified by end market. For example, a company providing SaaS for healthcare might be categorized under “Healthcare” rather than “Technology” or “Software.”

Analysts believe that the private credit market is undergoing two simultaneous “unwinding” processes.

First, the logic of lending to software companies has collapsed. Annual Recurring Revenue (ARR) was once seen as providing stable, bond-like cash flows, with predictable payments justifying loans even when free cash flow was negative. But this argument depended on the belief that subscription revenue would remain stable. When business models suddenly face obsolescence risk, “stable annuities” become a binary bet.

Second, the attractiveness of private credit itself is waning. As public market yields continue to chase higher returns, the promised “liquidity premium” no longer seems as attractive. The so-called “flight-to-quality” effect — with no daily mark-to-market, limited volatility, and the ability to stay calm during storms — becomes harder to sell when defaults are now viewed as real risks, and every headline in the market seems related to large exposures.

A Death Spiral Is Forming

Jeffrey Favuzza of Jefferies’ equity trading division describes the current situation as the “SaaS Apocalypse,” pointing out that the current trading style is entirely a panic sell of “get me out at any cost,” with no signs of stabilization.

Analysis from JPMorgan and Goldman Sachs shows that the market is experiencing unprecedented divergence: on one side are semiconductor companies benefiting from the AI supercycle, and on the other are software companies seen as the biggest losers. This divergence is creating a dangerous negative feedback loop.

As software equity valuations plummet, private credit institutions face pressure to revalue their assets and liabilities, which could lead to tighter lending conditions. This, in turn, could further squeeze the growth prospects of software companies already in survival mode. Loans trading at distressed levels will find it difficult to access traditional debt markets, exacerbating funding difficulties.

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