The Credit View: The Enduring Principles of Software Investing in the Age of AI (Newsletter)
The narrative has evolved, but our principles are unchanged
This year has represented a paradigm shift for software, and that shift has changed how investors—including ourselves—evaluate the sector. Not long ago, discussions about software centered on growth rates. Today, they often begin with concerns over AI disruption, irrespective of the risks faced by a given company. That shift has been most pronounced in the public equity markets, where software companies have repriced, in many cases dramatically. While that makes sense to us, the indiscriminate selloff of software loans does not. Our software loans sit senior in the capital structure and have significant margins of safety—if we lend at ~6x EBITDA on a business that was once valued at 20x EBITDA and is now worth 10x EBITDA—even after its valuation has been cut in half—our loan remains well covered.
Undeniably, AI represents the most significant technological shift we've seen since the dawn of the internet, and the market is right to reassess risk in response. While software valuations have broadly reset, the underlying software market continues to grow. Gartner recently increased its forecast for worldwide software spending in 2026 to approximately $1.44 trillion, a 15.1% increase over 2025, driven by stronger-than-expected demand for AI-enabled software. To us, this suggests the next phase of this cycle will be more company-specific.
The implication for investors is that success will increasingly depend on distinguishing businesses whose competitive advantages and end markets are strengthened by AI from those whose businesses become more vulnerable as technology evolves. We are confident that in many cases, existing software companies are best positioned to utilize AI to their advantage, particularly when supported by leading sponsors that can leverage deep expertise and resources across their firms to drive enhancements. These are the same types of companies that make up the majority of our software portfolio at NMFC.
Our focus remains on operating models and end markets
After more than twenty years of investing in software across New Mountain, we've found that the label “software” tells you very little about the underlying business model. Software businesses serve distinct end markets, compete in different ways, and possess unique competitive advantages. In the age of AI, those distinctions matter even more.
When we underwrite a software company, we start by understanding the end market because healthcare software, aviation software, and infrastructure software each require a different underwriting lens. While all three share many of the characteristics we consistently seek in defensive growth businesses, each has its own competitive dynamics, customer needs, and pace of technological change. From there, we evaluate the characteristics that ultimately determine durability: mission-critical applications, deep workflow integration, systems-of-record functionality, proprietary data, and network effects. Businesses with those advantages, and that serve attractive, growing end markets, behave very differently from software that is easier to substitute or that serves challenged end markets.
We specialize in durable advantages in the age of AI
We're already seeing those distinctions play out across the companies we are invested in and are evaluating. As NMFC assesses existing portfolio companies and new investment opportunities, our underwriting process examines where technological advancements, including AI, can reinforce competitive advantages and where they may erode them. Proprietary data is one example. Businesses with differentiated, owned datasets can use AI to leverage information they've spent years collecting to improve products, deliver richer insights and become more embedded in customer workflows, all while building on assets and customer relationships that competitors can't quickly replicate. By contrast, we have passed on opportunities where companies rely on publicly available data that AI can now easily scrape and manipulate, weakening the value proposition.
That perspective has developed over time. Software serving distinct, attractive end markets and use cases has been one of New Mountain's core power alleys for more than two decades. Over that time, the platform has invested approximately $12 billion across software, supporting 12 private equity and more than 120 credit portfolio companies while drawing on a network of more than 60 senior advisors with deep software expertise. As AI began reshaping the sector, New Mountain formed an AI Steering Committee to bring together investors, operators and outside experts to evaluate both existing portfolio companies and new investment opportunities.
Owning software businesses on the private equity side also gives us a real-time view of how AI is transforming them, allowing us to ensure the companies we lend to are equally front-footed. For NMFC, that platform expertise informs how we assess software credit risk throughout the investment lifecycle.
Defensive portfolios are positioned for market resets
One thing we've come to appreciate over the past year is that periods like this often create the best opportunities for specialists. We have built our philosophy on defensive, recession-resistant industries for moments like this, not to avoid them.
Markets naturally paint with too broad a brush when uncertainty is high, grouping resilient businesses together with challenged ones before the differences become obvious. We believe that is happening across the software market today.
In our view, the repricing we've seen across software equity valuations was warranted. However, equity values can be conservatively reassessed while senior loans remain well covered with meaningful equity supporting the debt. AI is likely to pressure some software business models while strengthening others, which is why NMFC’s focus remains on lending to companies with durable end-market positions, embedded workflows, proprietary data, and meaningful equity support beneath our debt.
In today’s environment, we believe deep sector expertise and disciplined underwriting become increasingly valuable because the market will reward investors who can distinguish AI-reinforced moats from more vulnerable business models. Investors who continue evaluating software as a single category risk overlooking businesses whose competitive advantages are becoming stronger as AI evolves.
View source version on LinkedIn and subscribe for future updates: https://www.linkedin.com/pulse/enduring-principles-software-investing-age-ai-john-kline-ypipc/