Software finance company Tideline Capital recently closed a $100 million conduit facility with Wachovia Securities backed exclusively by software receivables.

The vehicle is designed to finance enterprise software purchases averaging $500,000 in size, said Eric Wright, CEO of Tideline Capital. Tideline - which was launched last May - essentially acts as an outsourced financing arm for the software companies. Due to regulatory constraints that prohibit software companies from financing and booking revenue on the same transaction, most software companies are unable to maintain captive finance arms. "We do the credit work, we underwrite the transaction and then we originate that transaction into the conduit facility," Wright explained.

The types of companies looking to fund software purchases through the conduit will be middle market credits, Wright said. "We will take investment grade credits and give them to large institutions with cheap money. This facility will allow us to do some of the harder credits," he added.

The end goal is to bring a term ABS deal to market. The timing of the deal is uncertain, said Mark McCall, a director at Wachovia, and it could still be a couple of years away. "It's primarily a matter of getting a pool size that's large enough for a term transaction," McCall said, adding that it will be easier to access the term market once Tideline has a more established operating history.

Typically, at least $200 million makes for an economical term transaction at Wachovia, McCall said. However, there are no hard and fast rules, and a deal could be done with a pool as small as $100 million, he added.

Tidewater was conceived in response to the fickle nature of funding sources serving the software industry. "Software companies were struggling with the lack of reliable funding in the industry," Wright said.

Some banks and large financing operations will finance software, but only as part of a larger hardware package. "They might finance [a transaction] with 20% software...They are really doing hardware financing and doing a little software on the side because they felt the [hardware] collateral would cover for it," McCall said. "They are trying to make hardware act like software, and the two are profoundly different."

Software vendors will sometimes extend a line of credit to customers, but this can wreak havoc on a balance sheet. "Their receivables would explode, and over time, the balance sheet would start to get more and more out of whack," Wright said.

Fish or Fowl?

As an asset class, software receivables are somewhat of a hybrid between intellectual property and equipment. While the cashflow is a straightforward stream of receivables, the lack of a hard asset to reclaim in the event of a default gives it an intangible quality. Moreover, even if there were some sort of repossession, intellectual property laws would inhibit the resale of the product. However, as the holder of the cashflow, Tidewater retains the right to terminate the vendor's support services should the obligor fail to pay, said Peter Dopsch, a partner with law firm Morrison & Foerster. "It is an alternative form of enforcement," Dopsch said.

It is notoriously hard to put a value on an intangible asset, yet it could be argued that in this instance, the market has already done so, Wright said. Nonetheless, securing a rating could be a tricky prospect. "Eventually, we have to get the rating agencies to look at this, and they may disagree with that assessment," Wright said.

Wachovia's McCall views these credits as commercial, similar in nature to small business loans and equipment leases. The securitization technology is a combination of equipment technology and middle market loan technology, he said. "There is a strong business purpose for these loans, which helps the credit profile. These companies are buying mission critical software, so the propensity to pay is going to be very high, McCall added.

Copyright 2005 Thomson Media Inc. All Rights Reserved.

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