“The startup world was spooked into driving a fully operational car over the cliff.” Bob Crimmins, General Partner, Startup Haven Adventures
Credit: Kyle Calzia
The recent collapse of Silicon Valley Bank (SVB) has caused concern among investors and entrepreneurs in the startup world. The failure of the 40-year-old institution became the largest bank crash since the 2008 financial crisis, and put nearly $175 billion in customer deposits under U.S. regulator’s control. This article will explore the potential impacts of SVB’s collapse on the Silicon Valley’s startup ecosystem by analyzing how SVB was utilized by its biggest customers, the diversification and re-evaluation of cash strategies, how a variation of contracts and clauses played a pivotal role, and overall due diligence that led some companies to the position they found themselves in on March 10, 2023.
SVB’s Biggest Customers
SVB was the primary bank for many startups in Silicon Valley and their failure has caused widespread panic and uncertainty in the startup community. SVB’s biggest customers include Circle, Roku, Block-Fi, and Roblox who had financial ties with the bank totaling $3.3 billion, $487 million, $227 million, and $150 million respectively. Startup companies were particularly attracted to SVB because it tailored its offerings to meet their needs including their willingness to extend venture debt to companies in their early stages.
Venture Debt is a type of financing often used by startup companies who have already attracted venture capital investors. This type of debt is typically offered at higher interest rates and shorter terms than other forms of debt, but does not dilute the owner’s equity or require them to give up any control of their company. Because of this, venture debt is ideal to extend a startups runway between venture capital funding rounds or financing a specific project or investment.
Startups seek out venture debt because they usually lack the required cash flow and financial metrics to qualify for a traditional business loan. Instead of these traditional metrics, venture debt lenders look into others like the track records of the current investors, how much the startup has raised in prior rounds, and the company's potential.
Diversification and the Re-evaluation of Cash Strategies
In the wake of SVB’s collapse, many startups will adopt a more cautious approach to diversification and risk management. Co-founder and former CEO of Zillow Group, Spencer Rascoff, said that he’s “been in thousands of board meetings for startups and less than 1% of the time has the name of the bank or the treasury management program been discussed. This will change.” Investors will likely insist that founders exercise more caution by spreading their funds across multiple bank accounts and ensuring that they keep balances below the $250,000 FDIC insured limit in any single fund.
Roku (NASDAQ: ROKU) was hit hard by the SVB collapse; they held approximately $487 million with SVB about 26% of the company's cash. They are left in a tight spot, unsure how much money they will be able to recover as most of their deposits with SVB were uninsured.
On the other hand, Roblox (NASDAQ: RBLX) is in a better position. SVB held approximately $150 million or about 5% of the company's cash. The lesson for companies is to spread out their holdings as much as possible so there is no single point of failure and any one bank collapsing would have a smaller impact on the company.
However, SVB entered into loan covenants and exclusivity clauses limiting its customers ability to diversify.
Loan Covenants and Exclusivity Clauses
The second area of concern are the major effects on key documents, covenants, and agreements that companies had with SVB.
Loan Covenants
One of these major covenants are the loan covenants. In short, loan covenants or agreements are “a series of small, independent agreements made between a debtor (borrower) and a creditor (lender).” These covenants are behaviors or guidelines that the debtor must follow to earn incentives or to mitigate risks. Any violation of these covenants calls for a debt default or specifically a covenant breach. Defaulting could lead to consequences ranging from inability to secure future loans to the possible seizure of assets.
This is the exact situation that some of the top companies do not want. In this case, SVB’s loan agreement contained a loan covenant that required customers to keep money with the now-defunct bank. With the news of the SVB collapse circulating in the Valley, companies are looking to refinance with other loan providers, said John Markell, Armentum Partners’ Managing Partner. These companies are seeking a safer and more risk-tolerant way to store their funds, but doing so could risk a possible covenant breach resulting in a debt default. The possibility of an auction for the bank’s estimated $87 million loan portfolio is being considered, but some companies are not willing to wait. Despite the consequences of breaching loan covenants, they are looking for other options.
It is yet to be seen on how soon the bank’s portfolio will sell and how long companies will wait before risking a possible default. But some options offered by the Federal Deposits Insurance Commission (FDIC), as they transferred the now-defunct bank to the Silicon Valley Bridge Bank, National Association (SVBBNA), are that the SVBBNA could: (1) enforce every term of the agreement, (2) perform obligations under the transferred contracts, and/or (3) make timely payments to third parties. All of which, if a company fails to complete them or disregards the obligations, could result in the commencement of legal action.
Exclusivity Clauses
Some of SVB’s clients had exclusivity clauses with the bank limiting their ability to utilize services from other banks and most germane, making it impossible for those clients to safely diversify their savings. The clauses required companies to maintain accounts with the bank and in some cases, required companies to use the bank for most or all of their services. These clauses cause concern because the U.S. regulators only insure up to $250,000, which means that some companies won’t be able to access their funds.
For example, the electronic document software company, Docusign (NASDAQ: DOCU), signed an exclusivity agreement with the now-defunct bank in May of 2015. The agreement required the company to maintain primary accounts with the bank, but were still able to hold already existing, secondary accounts with Wells Fargo. This presents a huge problem because if Docusign does breach this contract, it could lead to a possible loss of key assets and securities.
On the other hand, some companies are not wholly affected by the collapse of SVB. Dexcom (NASDAQ: DXCM), the glucose monitoring company, also signed an exclusivity agreement with the bank in 2012, which required the company to hold a “majority” of its securities and accounts with the bank. Although Dexcom used to have an exclusive relationship, with the contract expiring in 2016, SVB now only holds about $2.7 million of the over $2.5 billion worth of securities the company currently has.
It will be interesting to see the future impact that some of these agreements and covenants have on companies. As it's currently constructed, many of these legal documents are preventing companies from freeing up much needed assets and leaving some companies, over others, in a state of worry and concern.
Impact on the Venture Capital Market
SVB’s collapse will likely lead to a movement away from venture debt and towards safety. Startups will likely perform more comprehensive due diligence ensuring that financial institutions they chose to bank with are not at risk of collapse. Companies may turn to larger banking institutions as a result.
This could be bad for the venture capital market as VC firms look to partner with upcoming companies, which allow the firms to take on equity from the company while supplying the companies with much needed capital. But with all the heightened anxiety around early stage companies and an unstable “startup ecosystem,” investors are more likely to also be more hesitant in investing in such risky ventures, such as early technology startups. Id.
Others are optimistic that SVB’s collapse could actually be a boon for the VC market. Kirby Winfield, founding general partner of Seattle venture capital firm Ascend, predicts that “[i]f rates stop increasing I’d bet investors will resume typical deployment pacing with confidence of a more capital-friendly environment in the near to medium-term.” At the same time, Winfield explained that the bank’s collapse could see the Federal Reserve easing up on the interest rates as well, which would spark more interest back into investing in startups, however it remains to be seen if this is the case.
The SVB collapse has given Silicon Valley companies a wake up call. They need to consider new financial avenues while balancing the highest value and practicality for the lowest risk tolerance. The impact of SVB's collapse on the Silicon Valley’s startup ecosystem will be felt for some time to come.
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*The views expressed in this article do not represent the views of Santa Clara University.