What the SVB saga means for fundraising (spoiler: nothing good)
In case you haven’t heard, Silicon Valley Bank, the 16th largest bank in the US and the number one bank for venture-backed startups, failed last week.
In preparing for this essay, I envisioned a much scarier scenario. While the total disaster was averted, those of us who plan to raise capital have much to prepare for, and I want you to be prepared.
The impacts on fundraising and recommendations will follow, but first…
SVB became a top 20 bank in the USA thanks to its support of tech startups and easing of regulations. In this case, success is not always good
To begin, let’s review the banking business
To understand the disaster, you must understand how banks work. Banking basics:
It is the bank’s business to take deposits from customers and lend that money to generate interest.
It would be impossible for a bank to make money if it kept 100% of its deposits available for withdrawal. Laws require a bank to maintain cash or liquid assets (loans that can be converted to cash in a short time). For depositors to have access to funds, banks manage the ratio between longer-term loans (those that produce higher interest rates but are hard to convert into cash) and cash and cash equivalents (their Liquidity Ratio). It is through this Liquidity Ratio balancing act that they maximize profits…
Bank balancing act flaws
In the banking business, there are many risks involved. Before discussing SVB, we need to discuss two relevant ones.
Risk #1 – Lower returns on longer-term investments
Risk #2 – Higher than expected withdrawals from depositors
The two specific risks I listed are the two blows that destroyed SVB. In combination with horrible communication management, the bank was doomed. In the world of tech startups, this was HUGE. The Silicon Valley Bank played an important role in the ecosystem. Over 2500 venture capital firms and almost half of all US tech startups deposited $175B with them.
From Novela Neurotech, which I invested in, to Roku, a public company with almost $500M trapped at SVB, thousands of companies believed they could access only $250k of their capital. When a company cannot run payroll, it faces extinction-level disruption. Bankruptcies were imminent for many companies that employed thousands. Although the government intervened to guarantee depositors’ money, there are still massive impacts on the ecosystem.
Here’s why it’s still a huge blow
What is the value of that dress you’re wearing?
How about the apartment you live in?
Raising capital for your startup?
Each answer is the same. Things are worth what people are willing to pay. Valuing something may seem easier when it generates revenue or has measurable utility. Even then, you are baking in some future value when valuing any asset. Anytime you think about the future, it’s uncertain. Basically… there’s a risk.
Markets’ risk appetite heavily influences how much they are willing to pay for something. A high degree of uncertainty is inherent to investing in early-stage companies.
The passion for future opportunities, the willingness to take risks, and the confidence in the system drive startup investments. Over the past 15 years, startups around the world, especially in the US, have enjoyed a high level of confidence. What are the limits of markets?
An ongoing series of setbacks…
The market was in raging good times at the beginning of 2022, but Russia’s invasion of Ukraine in February triggered a correction many had predicted 7-8 years ago. Recall discussing this at our 2015 IC meeting, but the buoyant markets and recent COVID developments have clouded my memory.
Despite uncertainty and pullbacks, VCs continued to invest. There was still a sense of excitement and optimism. After the collapse of Luna in May 2022, there was the first crypto crash. After 5 months, FTX failed. Following a four-month respite, SVB collapsed.
In each situation, I saw the industry rallying and picking itself up between unexpected shocks. It was time for the startup fundraising market to return and let capital flow freely to support innovation and growth. As I talked to many investors, they were excited to get deals done since they had just gotten back from the sidelines. This is the fourth shock to hit this institution in less than a year, and I fear it will have a lasting impact on the startup market. While it may appear that startups with SVB capital were spared, this may not be true for the market’s confidence or tolerance for risk.
What lies ahead / recommendations
Here are my expectations if you’ve read this far.
Investments in venture capital will not plummet to zilch. Too much capital awaits deployment. While confidence rebuilds in a shaky economy, dollars will be bottled up for at least six months and slowly released over that time. We are still expecting the intrepid investors to lead the charge in 2023, but their expectation level for investing is going to be higher this time around.
Is it fair to blame them?
What do you think check-writers will do with a pre-revenue startup if we can no longer blindly throw money into a bank? As a result, it will be difficult to access capital. Double your runway if you have X months before raising money. It is a good idea to raise more capital than you think you will need if you have the ability to raise it.
It is not enough to have a few proof points, a certain level of traction, or a reasonable level of relationship. You would need to do more.
Another way to put it is that you need to create a lot more comfort and confidence for them before they take the plunge.
Here is what I am doing and what I would like you to do:
- Focus on improving customer understanding and overall operations to boost business operations.
- Increase runway by quickly taking action, reducing headcount, and cutting non-essential expenses.
- Keep in mind that active investors set market expectations, and valuations may not reflect those from 6-24 months ago. Expect an adjustment.
- Plan ahead for fundraising by preparing early and building relationships with potential investors.
Use the current constraints and pressures to create a better business. Remember, pressure creates diamonds.
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