The collapse of Silicon Valley Bank sent shockwaves through the venture capital and private equity communities. That’s partly because SVB played a critical role in those communities, serving as a one-stop shop for the VC and PE markets. It provided venture debt to pre-profitable venture-backed companies at reasonable rates. It held the deposits of many startups. It also offered a variety of services to venture and PE funds themselves, such as subscription line agreements – lines of credit for capital calls secured against the limited partner commitments in a fund. SVB itself has said that more than 50% of U.S. venture-backed tech and life sciences businesses had some sort of relationship with the bank.
In the aftermath of SVB’s implosion, a lot of blame was hung on its executives. One bank insider criticized SVB management for publicly announcing, in one salvo, the triple whammy of a $1.8 billion loss, a hope to raise $2.25 billion in capital, and a plan to sell $21 billion in assets. Predictably, panic ensued among SVB depositors.
But some blame should be hung on depositors as well. The fact that some tech companies had nearly all of their liquid capital tied up in SVB – and that their VC and PE backers allowed this to happen – is mindboggling. That’s why, going forward, I believe cash management and treasury risk should become boardroom issues for all companies. It will become prudent, indeed necessary, for companies to learn from the SVB disaster and maintain banking relationships with multiple institutions to ensure diversification and limit counterparty risk.
The SVB collapse will have far-reaching impacts. One of the most immediate will be a difficulty among startup companies to access capital. SVB was one of the biggest lenders to startups, and its disappearance will severely limit that tap. Thanks to SVB, venture-backed companies were able to take on venture debt at a reasonable cost without adding further shareholder dilution. Specifically, with the loss of Silicon Valley Bank, there will be much less venture debt financing available for early-stage startups. As a result, many will have to look elsewhere for capital, which ultimately could slow innovation and growth for startup companies. In fact, the loss of a major lender like SVB could crimp dealmaking overall.
There is another immediate issue in that while deposits are available, the lines of credit the companies relied on are not. This may cause severe operating difficulties until alternate financing, if possible, can be secured.
It’s possible that some non-bank private lenders will expand their presence in the venture debt sector and fill the void left by SVB. But that void is considerable. Despite the abundance of private credit available, only a small fraction is allocated to the venture market. Some non-bank lenders that have been thinking about entering the venture debt arena might see SVB’s demise as an opening; on the other hand, they might see it as a red flag and reassess their plans. I expect it will become more difficult for startups to find private debt at a reasonable cost, which will be a further drag on the VC market.
In the end, entrepreneurs may be looking at further shareholder dilution, especially if the financing gap left by SVB has to be filled by VC firms themselves. And that’s assuming those VC firms are even willing to put in additional capital. In the short term, VCs may start getting creative and offer bridge loans to their portfolio companies to help them make it to the next funding round.
It’s not just VCs that are impacted by the fall of SVB. It’s also private equity firms and their portfolio companies. Most PE firms that I’ve spoken to recently had at least one portfolio company at SVB. Now they too are wrestling with the question of what to do next. On top of that, they’re getting peppered with questions from their LPs about the treasury and cash management risks and controls within their portfolios, and whether portfolio companies have sufficiently diversified banking relationships.
Certainly, private equity firms will need to be more careful and better understand cash management and treasury risk controls at the portfolio company level to prevent SVB-type situations from occurring in the future. It will also be incumbent on PE firms to better manage counterparty risk, including how they assess and control risk at the portfolio company level. This focus on counterparty risk has resurfaced with a vengeance after fading away in the aftermath of the 2008-2009 financial crisis.
Once again, firms are being reminded of the speed at which unexpected events can occur. Today it’s SVB, tomorrow it might be someone else. Like in any industry, the best defense is to spread your exposure and avoid relying too much on one entity. For example, a manufacturing business that relies on one supplier for a crucial component exposes itself to a large counterparty risk: If that supplier fails, production can be disrupted and cash flow impacted, and the entire business could face closure. Banking is no different.
In the VC and PE communities, it’s critical that firms now do some diligence, gain a deep understanding of their counterparty risk, and put better controls and contingency plans in place. This will involve analyzing the potential risks associated with each portfolio company, as well as assessing overall risk at the fund level. By taking proactive measures to identify and mitigate concentration and counterparty risks, VC and PE firms can safeguard the long-term sustainability of their investments – and their business.