In late 2020, Silicon Valley Bank vice-president Armando Argueta offered a word of caution to any start-up founder considering loans from less-established lenders.
“Many players come and go in the venture debt market, so make sure that whomever you are talking to is a long-term player. When a bank decides one day that it is no longer interested in lending venture debt, it can wreak havoc on your business,” he wrote in a post on SVB’s website.
Since SVB’s collapse earlier this month, founders are learning the hard way how true those words are. The bank was the pioneer and linchpin of a venture debt market that gave start-ups an alternative source of funding, without the need to sacrifice equity stakes or swallow a much lower valuation.
Across the US, SVB was responsible for roughly one-tenth of all venture debt issued in the year so far. But on its home turf in California, the bank was behind more than 60 per cent of all deals this year, according to data from Preqin.
Founders and investors fear that the demise of the tech sector’s favourite bank will ripple through to lower valuations and hasten company collapses amid an already tough funding environment, according to more than a dozen people interviewed by the Financial Times.
SVB’s collapse “will have a devastating impact on the ecosystem”, said Alessandro Chesser, chief executive of start-up Dynasty, which creates trusts.
“Larger companies relying on venture debt are in lots of trouble right now. Unless things turn around quickly, we’re going to see a lot of high-value start-ups going out of business.”
Venture debt is typically issued to companies that have already raised equity in at least two or three rounds, with the earlier backing of venture capitalists providing confidence to lenders.
Private tech companies have been relying on debt in larger numbers than previously, as rising interest rates reduce the amount of equity funding available for start-ups.
The big draw for a lot of the tech companies going to SVB was because they offered a bank-like facility where they could draw money over a very long period of time
A report published this week by GP Bullhound, a tech investment and advisory firm, found that debt issuance to European tech companies doubled to €30.5 billion last year compared with 2021.
Debt was around 30 per cent of all venture capital raised in European tech in 2022, according to figures from Dealroom, compared with around 16 per cent in the previous six years. Cleantech and fintech companies were among the biggest borrowers.
Olya Klueppel, head of credit at GP Bullhound, said the increase reflected equity investors’ pullback from tech as well as acquisitive companies seeking to take advantage of falling valuations. “Terms have changed quite significantly in favour of lenders,” she added.
In the US, the venture debt market provided a lifeline last year as the pool of available venture capital shrunk. Total debt issuance was $32 billion (€29.6 billion), in line with 2021, even as venture capital fell sharply from $345 billion in 2021 to $238 billion, according to data from PitchBook.
Access to venture debt has also been a way for start-ups such as Allie Egan’s to buy some extra time or put cash in the bank for a rainy day.
“We took on the venture debt line as an extra option, and we want to keep that because the name of the game is uncertainty right now. The more you can safeguard, the better,” said Egan, founder of digital health company Veracity Selfcare.
With SVB in the hands of the government and currently being auctioned off by regulators, founders are anxious that access to debt will dry up and existing loans may even come under pressure.
“There definitely won’t be the same degree of venture debt available – you can go to [neobank] Mercury and others, but the terms are worse and is that safer?” said Egan. “It’s sad – the environment is going to drastically change, it’s going to make it harder to innovate.”
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SVB gained favour with start-ups thanks to its close relationship with their venture capital backers and by being “extremely competitive” on pricing, said GP Bullhound’s Klueppel.
“The big draw, also, for a lot of the tech companies going to SVB was because they offered a bank-like facility where they could draw money over a very long period of time,” she added.
There is now uncertainty for start-ups who arranged those facilities with SVB but never drew down on them.
“We do have inquiries from companies who are thinking about what will happen in the next couple of months, whether those facilities will still be available and if it is possible to refinance those facilities,” said Klueppel. “Boards are looking for options to diversify.”
Those anxieties exist both in the UK, where SVB UK has been sold to HSBC, and in the US, where the sale process is ongoing.
For SVB, which banked start-ups and their venture capital backers, lending to founders at relatively low rates was a viable business – not least because it often mandated that companies park their deposits at the bank in return.
One venture capitalist told the FT that he advised his portfolio companies to start their banking relationships at more mainstream institutions such as JPMorgan. That way, when they came to the stage where they wanted venture debt, they could use the promise of larger deposits to barter better terms with SVB.
Unless things turn around quickly, we’re going to see a lot of high-value start-ups going out of business
In exchange for debt issued at rates that were more generous compared to peers, SVB often took warrants that could convert to shares once a company exited, and benefited from closer ties both to the start-up and their venture backers.
But, shorn of those relationships, it is less clear how much value SVB’s $6.7 billion US loan book has. Much of that lending is to start-ups with “modest or negative cash flows and/or no established record of profitable operations”, according to the company’s annual report.
The bank lent to venture-backed companies and expected loans to be repaid when they raised fresh capital or managed to list publicly. But neither are guaranteed outcomes in the current market.
The loan book has yet to find a buyer, despite the Federal Deposit Insurance Corporation extending its auction and broadening the pool of participants. Even if an acquirer is found, few customers of SVB in the US or in Europe expect business to continue as before.
Without a supply of debt, companies will be increasingly beholden to venture backers, said Maëlle Gavet, chief executive of Techstars, one of the world’s largest investors in early-stage start-ups.
“You are asking for more, and in the market we’ve experienced over the last eight months, with valuations going down and venture capitalists being pretty careful when it comes to their investments, the VCs are going to have an even more powerful position.” – Copyright The Financial Times Limited 2023
