Why Startups Must Rethink Their Credit Strategy


The liquidity crisis at Silicon Valley Bank (SVB) has added to the woes of the already struggling startup ecosystem 

The loss of deposits from SVB, which catered specifically to the technology industry, has put pressure on the cash flows of many startups 

While the collapse of SVB was unrelated to the funding slowdown, its demise is likely to have a knock-on effect on the venture capital space 

The sudden crisis at Silicon Valley Bank (SVB) has brought to light new challenges for the startup ecosystem, which was already stressed with the prospect of a funding drought and an impending economic downturn. The liquidity crisis has deprived startups of their deposits, posing a threat to their cash flows overnight.

Regarding the event, billionaire investor Ray Dalio said, “Based on my understanding of this dynamic and what is now happening (which line up), this bank failure is a ‘canary in the coal mine’ early-sign dynamic that will have knock-on effects in the venture world and well beyond it.” 

The startup industry has been grappling with financial difficulties as funding levels hit their lowest in five years, making venture capital investors more apprehensive and wealthy angels withhold their investments. To make matters worse, the sudden collapse of SVB has forced business owners to focus solely on cash flow management and has taken away control over their operations.

As per CB Insights, tech startups in the Silicon Valley raised less than $10 Bn in the fourth quarter, the smallest amount since 2017. Furthermore, only 465 deals were concluded during this period, which marked the lowest figure in five years. Interestingly, SVB’s collapse was not related to the funding decline. Rather, it resulted from the bank’s poor management of duration risk, which led to a $15 Bn loss to its balance sheet.

SVB had established itself as the preferred financier for technology entrepreneurs, with a comprehensive range of services and products tailored to the requirements of both founders and investors. Its offerings included funding for ownership stakes in private or public firms and investment support in venture capital or private equity funds. Additionally, SVB pioneered the venture debt industry by providing loans to startups in their early stages. The bank’s approach to basic financial services was also welcomed by business owners that experienced significant delays in setting up similar services with traditional banks.

Government Actions

  • The US Administration determined SVB and Signature Bank to be systemically important financial institutions (SIFIs), a designation usually reserved for the largest banks.
  • SVB and Signature Bank depositors were given full access to their funds, starting Monday, March 13, including uninsured deposits above $250K.
  • The Federal Reserve created the Bank Term Funding Program (BTFP), a new liquidity facility designed to allow banks, savings associations, credit unions, and other depository institutions to swap safe assets (i.e., high-quality assets) for cash. The swap is a loan that lasts up to a year, and the collateral used includes assets such as US Treasuries, agency securities, or agency mortgage-backed securities. The Fed would accept these assets for 100 cents on the dollar, even if their value has fallen. The BTFP is meant to shift the risk of rescues to the private sector rather than taxpayers, but the government may have to absorb any losses on these loans if they are not repaid in full.
  • The Treasury is expected to help backstop the Fed’s BTFP with $25 Bn from its Exchange Stabilization Fund.

Although the government has stepped in to insure deposits for the time being, the sentiment has turned negative. Startups are increasingly looking for alternative sources of funding to meet their everyday cash requirements and weather the storm for the short and long terms.

In Search Of Interim Financing

The depositors, primarily startups, faced major obstacles in meeting their daily business cash requirements. To address this issue, a growing number of funding platforms (such as Klub Works, Recur Club, and GetVantage) are now offering near-term solutions to help startups manage their cash flow needs. These services allow startups access to credit against frozen SVB deposits as well as future working capital.

For example, Recur Club has received enquiries from over 100 startups, while GetVantage is offering a loan of $250K to startups affected by the SVB collapse. Meanwhile, revenue-based financing firm Klub is providing “emergency financing of up to $400K within 48 hours” to distressed startups. These firms offer capital solutions for all use cases, including working capital, inventory financing, and payroll.

In response to this crisis, some governments and financial institutions are taking bold steps to provide much-needed relief to local startups. For instance, the International Financial Services Centre Authority in Gujarat’s GIFT City allows clients to open foreign currency accounts for international transactions, proving a lifeline for many Indian startups. Meanwhile, in the UK, HSBC’s recent acquisition of SVB for just €1 has secured the deposits of SVB customers in the country.

Long-Term Shift In Funding

Even if the bank assets are transferred, which may continue under a new name, it is expected to have major repercussions for investors and tech firms. Deals such as venture debt financing and funding rounds are likely to be affected, making it more difficult for startups to secure the necessary funding. 

Moreover, the ongoing uncertainty has prompted many startups to seek alternative banking options, putting more pressure on the distressed financial sector. This situation has been compounded by the sharp decline of Credit Suisse Group AG, which has dragged down other major institutions with it. Although UBS has finalised a deal to acquire Credit Suisse, the road ahead is full of uncertainties.

Global Venture Dollar Volume (2013-2022)

According to Crunchbase, venture capital investors in private firms scaled back their investment at a rapid pace in the latter half of 2022, indicating a slower funding environment with the start of the year 2023. This, together with the recent banking crisis, may lead to a fundamental shift in the startup ecosystem as companies start getting more worried about cash management.

There is renewed interest in stability and profitability over the need for scale. It would be worthwhile to know if this event becomes a pivotal moment in the startup funding cycle. Will the reliance on traditional sources of funding such as bootstrapping, crowdfunding, and bank loans increase, or will the current dominance of venture capital funds sustain?

 



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