SVB’s Failure Means ‘Easiest Money’ for Startups Is Gone

For decades, SVB was seen as a vital—if under-the-radar—cog that kept the tech engine humming. Its failure is likely to reduce a key source of capital for Silicon Valley at the very time that capital has become harder to raise, investors say.

The fallout could be widespread in the near term. The banking panic of the past few days could cause some investors to delay or reassess private tech investments generally, waiting for the dust to settle. But even once dealmaking picks back up, SVB’s presence will be missed.

“Venture debt will be the first thing that shifts quite a lot,” said Rich Boyle, a general partner at Canaan, an early-stage venture capital firm. “SVB was the most prominent lender in the category. They set the terms in the market and were more favorable to companies than other lenders.”

SVB is now under the control of the Federal Deposit Insurance Corp., which is seeking a buyer for the bank. There’s no guarantee a buyer would adopt SVB’s startup-friendly style. Its bankers were known to call early-stage companies as soon as they raised their first rounds of capital. Young companies rarely announced the loans they took out alongside equity financing rounds from venture capitalists. But the additional capital helped startups delay the need to raise more money until they could seal higher valuations.

The bank underwrote loans to younger companies based on the firms’ ability to keep raising VC money rather than their profits, which were typically nonexistent. The likelihood of startups raising more venture capital helped the lender gain more certainty over repayment. SVB became the largest issuer of venture debt, reporting about $6.7 billion in loans to early- and mid-stage private companies last year, according to researchers and securities filings. That easily outpaced other publicly traded tech lenders, filings show.

The lending business powered it to a dominant market position in tech banking. As a condition of their loans, SVB required startups to keep all or nearly all of their money with it, which lawyers say is typical for startup lenders. Startups also used SVB for other banking services such as mutual fund investing. SVB told investors it banked nearly half of all U.S. tech and life sciences startups.

The bank was able to offer low-cost financing to startups because of its large deposit base, according to an employee of SVB’s lending arm, who spoke on the condition of anonymity.

Structural Impact

All that means SVB’s failure “has real structural impact,” said Haim Zaltzman, chair of Latham and Watkins’ San Francisco Bay Area finance practice. “It will be very difficult to replace SVB and its role as it existed. It’s an essential part of the tech and life science ecosystem.”

SVB wasn’t the only lender to startups. In fact, bigger institutions have jumped into the sector through acquisition of other firms lately.  Asset manager P10 bought longtime venture debt lender Western Technology Investment earlier this year. Private equity giant KKR held talks to buy a venture lender last year, The Information previously reported. Even startup Brex launched a venture lending business last year.

But SVB stood out from its competitors for its flexibility and close ties with VC firms and Silicon Valley law firms. Startups saw SVB as a flexible partner who would work with them even if they breached the conditions of their loans, according to investors and lawyers who dealt with the bank.

Bankers at SVB recently proved forgiving when his startup ran into trouble, Herndon from The Guild noted. Venture capitalists backed out of a funding round last year while the company still owed money to SVB. “I don’t know if another bank would’ve shut us down in November when things were looking a little tight. They wanted to preserve the reputation as a startup founder–friendly bank.” The leeway gave The Guild time to pivot its business model from providing hospitality services to selling business software to other travel firms.

Some founders and investors perceived institutional banks as historically less responsive or less willing to lend to riskier startups with smaller loans. “If things turned bad, you could reason with them,” said Oren Zeev, an investor in startups including Navan, Houzz and Tipalti. “You didn’t have the feeling you were talking with faceless, ruthless bankers. You felt like you were talking with humans who understood the situation.”

Aside from startups, SVB also was a big lender to VC and private equity firms.

The majority of the bank’s loans were “capital call lines” to these types of firms, secured by the capital commitments of their limited partners, filings show. Fourteen percent of its loans were personal housing mortgages to clients, who were often prominent people in the tech world. The firm also lent billions of dollars to later-stage or publicly traded companies tied to their balance sheets rather than to specific VC deals. (See a searchable database of investment firms that used SVB as a custodian for their capital here.)

Even as the market soured last year, the firm was still busy lending money to early-stage startups, Daniel Beck, SVB’s chief financial officer, told investors in December. “Our teams are quite busy with a significant number of clients that may be Series A, Series B and beyond that are trying to either draw commitment or effectively take down some extension from a runway perspective,” he said.

In the end, SVB’s concentration in tech turned out to be a problem. As concerns about its balance sheet surfaced last week when the bank announced a stock raising, venture capitalists urged their portfolio companies to move money out.

Close Ties

“The unique thing about the situation is so many depositors of the bank are connected to the same venture capitalists,” said William Mann, an assistant professor of finance at Emory University who has studied VC and venture debt. “It gets back to the symbiotic nature of everything in the tech world. Whatever is bad for one piece of the entire ecosystem seems to be bad everybody.”

In an unpublished paper Mann co-wrote this year, he described his findings that venture debt was “surprisingly common for venture-backed companies.” The debt typically included monthly interest charges “at yields exceeding those of junk corporate bonds, with the expectation that the loan will ultimately be repaid through future rounds of equity financing,” according to loans issued by publicly traded SVB competitors, including Hercules and TriplePoint Venture Growth. The lenders typically used the firms’ intellectual property as primary collateral, whereas SVB typically got a senior secured position in the company, lawyers say.

Jeremy Abelson, founder of Irving Investors, which invests in public and private tech firms, said later-stage investors rarely pushed back on the idea of paying off debts the company had previously raised. SVB, he said, was the “most generous” of the tech lenders because the loans helped fuel its broader banking business.

“They were the easiest money for an unprofitable, early-stage to mid-stage tech company,” said Abelson. “That is gone.”

Herndon of The Guild thinks less availability of venture debt could be good for tech startups. “It’s all fun and good until the time to pay back the loan occurs,” he said. “I think we all would be better off burning a lot less cash.”