Monitor portfolio · PCT-073 · Sourced card
ARR loan covenants and the flip
A software lender holds a recurring revenue loan and needs each month's KPI pack tested against the ARR covenant, the liquidity floor and the conversion (flip) conditions.
Worked example: Both ARR covenants pass, but after deducting capitalised software, LTM EBITDA is negative ($1.2m). The borrower can’t elect conversion to EBITDA tests, and gross retention fell from 93% to 89% in three months. See the walk-through ↓
Today vs automated
- Read the KPI packAnalyst · manual
- Recompute ARR by handAnalyst · manual
- Check flip termsPM · manual
- Email / meeting hand-offAnalyst → PM
- The monthly KPI pack arrivesTrigger: starts on its own
- Apply the ARR definitionAutomated · Document store
- Test leverage and liquidityAutomated · LLM
- Flag flip readinessAI draft, human review · Monitoring model
- Whether a definitional gap is worth raising with the sponsorApprove / override · PM
AutomatedAI draft, human reviewHuman onlyTools: Inbox / portal, Document store, LLM, Monitoring model, Loan system
Estimated valueestimate
60–890 analyst hours a year
$9k–$222k of time, vs an assumed $10k–$40k tool cost
Net: −$31k to $212k a year net of tool cost; at the low end of the assumptions it does not cover the tool cost.
Assumptions
- 2–4 analyst hours per borrower month today; 0.3–1 hours with an agent, including review
- 60–240 borrower months a year for one team
- $150–250 per hour loaded cost
- Tool or build cost $10,000–40,000 a year (in-house)
Estimate, based on the assumptions shown; your numbers will differ. How we estimate
What else it can do for the team
- Model months until the liquidity floor at current burn
- Track retention trends against underwriting
- Prepare the conversion-date discussion
- Flag definitional gaps to raise with the sponsor
- Feed into the watchlist
Worked walk-throughKey catch: Both ARR covenants pass, but after deducting capitalised software, LTM EBITDA is negative ($1.2m). The borrower can’t elect conversion to EBITDA tests, and gross retention fell from 93% to 89% in three months.
1. The input
SAMPLE: fictional company, illustrative figures. Not a real borrower, deal or lender group.
Project Lattice’s September 2026 KPI pack and the credit agreement’s Recurring Revenue, liquidity and conversion terms. See the SAMPLE pack →
| Term | SAMPLE term sheet |
|---|---|
| Borrower | Project Lattice (fictional), vertical SaaS for specialty subcontractors, sponsor-backed |
| Facilities | $95.0m term loan; $10.0m revolver (undrawn at close, Dec 2025) |
| Sizing | About 1.5x Recurring Revenue at close |
| Pricing | Term SOFR + 6.25% before conversion; + 5.50% after |
| Covenants before conversion | Maximum Total Debt to Recurring Revenue 1.85x; Minimum Liquidity $12.0m (cash plus undrawn revolver), tested monthly |
| Conversion | Earlier of borrower election after month 12 (if Total Leverage is 7.00x or lower) and Q4 2028; then Maximum Total Leverage 7.00x stepping to 6.00x |
| EBITDA definition | After deducting capitalised software development costs |
| Recurring Revenue definition | Annualised contracted subscription revenue, excluding customers that have given notice of non-renewal or are 90+ days past due |
| Monthly KPI pack (SAMPLE) | Jul 26 | Aug 26 | Sep 26 |
|---|---|---|---|
| ARR as reported ($m) | 62.2 | 62.7 | 63.1 |
| Gross revenue retention (LTM) | 93% | 91% | 89% |
| Net revenue retention (LTM) | 106% | 105% | 104% |
| Cash ($m) | 10.2 | 9.3 | 8.4 |
| Capitalised software dev, LTM ($m) | 5.2 | ||
| Notes | Customer with $1.4m ARR gave notice of non-renewal on 12 Sep |
2. What the AI produces
| Test | As reported | Under the agreement | Note |
|---|---|---|---|
| Recurring Revenue | 63.1 | 61.7 | Customer on notice of non-renewal excluded by definition |
| Total Debt to Recurring Revenue (max 1.85x) | 1.51x | 1.54x | Passes |
| Minimum Liquidity (min $12.0m) | 18.4 | 18.4 | Passes; about 11 months at the current $0.6m monthly burn before the floor |
| EBITDA for conversion test (LTM) | +4.0 (company, before capitalised software) | -1.2 (after deducting 5.2) | Negative EBITDA: borrower cannot elect conversion |
| Gross revenue retention | 93% → 89% over 3 months | Trend flag, not a covenant |
3. What a person still checks
- Confirm with the company whether the notice customer is likely to churn or renegotiate.
- Read the EBITDA definition again: the company’s positive figure ignores capitalised software, which the agreement deducts.
- Decide whether falling gross retention warrants an earlier conversation about the 2028 conversion date.
4. Where it breaks
- Company ARR metrics rarely match the agreement’s definition line for line; the agent needs the customer-level schedule to apply exclusions.
- Liquidity can swing on revolver availability conditions not visible in the KPI pack.
- An ARR test passing tells you little about the path to the conversion test.
How you get thereFour steps from prompting to an agentic workflow; most teams start at step 2.
Needs: an approved AI tool, a confidentiality policy.
Risk: unchecked answers, data pasted outside policy.
Needs: field definitions, a template, document parsing.
Risk: breaks silently when formats change.
Typical starting point
Needs: inbox/doc-store access, system write-back, logging.
Risk: acting on a misread; needs review gates.
The automated lane above
Needs: shared data model, permissions, audit trail, exception queue.
Risk: errors compound across steps; needs monitoring.
Solution optionsBuy (8 vendors listed), build or hybrid, with the trade-offs of each.
Orion (Private Credit AI), Lumonic, Finley, Intain, CovenantIQ, Alkymi, Henon, Hypercore
Fastest start; you adapt to the product's data model and pricing.
An LLM API, a document parser, a vector or document store, your data warehouse, and a review queue.
Fits your definitions exactly; you own maintenance and controls.
Vendor extraction feeding your own checks, templates and systems.
Common middle path; two things to integrate and govern.
Listing is not endorsement.
What changes for the team2–4 h → 0.3–1 h per borrower month (estimate); coverage goes from a sample of borrowers, quarterly to every borrower, every delivery.
How it works
Full title: Recurring revenue loan: test ARR leverage and minimum liquidity, and check whether the borrower can flip to EBITDA
“ARR leverage looks fine. The flip test is the problem.”
Scenario
A software lender holds a recurring revenue loan and needs each month's KPI pack tested against the ARR covenant, the liquidity floor and the conversion (flip) conditions.
What the human still decides
Whether a definitional gap is worth raising with the sponsor, and how to respond if the company asks to defer conversion.
Why it matters
ARR loans carry covenant mechanics EBITDA loans don't (recurring revenue leverage, minimum liquidity, a conversion date), so monitoring templates built for EBITDA deals miss them.
What the record shows
Checked 2026-10-18.
DLA Piper's 2026 report finds minimum liquidity covenants in all ARR deals in its data set and a covenant conversion typically three to four years after closing; Latham's practice note describes conversion on the earlier of borrower election (subject to an EBITDA leverage test) or a date certain.
Try it: prompt and data
Using the credit agreement excerpt and this month's KPI pack, recompute Recurring Revenue under the agreement's definition, then test Total Debt to Recurring Revenue, Minimum Liquidity and the conversion leverage test. Show each figure with its source line. Flag any item counted by the company but excluded by the definition.
Data
Walk-through uses a SAMPLE deal pack: fictional company, illustrative figures. In practice the inputs are your own confidential borrower or fund documents; keep them inside an approved environment.
Who uses it, vendors and build
- Segments
- Direct lending, Venture debt
- Who uses it
- Portfolio manager, Credit analyst
- Build
- Buildable in-house
- In-house
- A definitions file plus a monthly script; few vendors package ARR-specific tests.
- Last verified
- 2026-10-15
Vendors that claim this capability
- Lumonic: covenant-tests, venture-runway
- Alkymi: covenant-tests
- CovenantIQ: covenant-tests
- Finley: covenant-tests
- Henon: covenant-tests
- 3 more vendors claim related capabilities. See all vendors for this stage →
Tags reflect each vendor's own public claims at the linked page (checked 2026-10-15). Not tested, ranked or endorsed.
Sources and related
- DLA Piper International Debt Finance Intelligence Report 2026: ARR financings, covenant conversion, minimum liquidity (PDF)
- Latham and Watkins / Practical Law: Recurring revenue loans, key considerations (PDF)
- Deal packs used in the walk-throughs (SAMPLE, fictional companies)
Related cards
- PCT-071 Every borrower's quarterly pack, spread into one monitoring model: covenant headroom tracked quarter by quarter
- PCT-002 Covenants, baskets and add-backs out of a 200-page credit agreement, every line cited to a section
- PCT-076 Early-warning brief across the book: financials, reporting behaviour, requests and news in one cited watchlist draft
Next step
Related use cases
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Not investment advice. Names marked SAMPLE are fictional. Found an error? See the corrections log.