The recent collapse of the renowned Silicon Valley Bank (SVB) is the most extensive banking crisis in the U.S. since 2008's catastrophic housing market crash.
On March 10th, SVB's stock price plummeted by 60% before Californian banking regulators moved to close it down. Since then, this banking lighthouse for startups and venture capital firms has been taken over by the Federal Deposit Insurance Corporation (FDIC), an arm of the U.S. government.
The U.S. government has since announced that all deposits in the SVB were safe, and nobody stands to lose any money. However, that did not stop the U.K. arm of SVB from being bought by HSBC for the princely sum of £1. Nor was it enough to prevent a second casualty - the Signature Bank, which states regulators in New York also closed down on March 12th. Furthermore, SVB’s active involvement with several Scandinavian unicorns like Klarna and Kry is further expected to cause short-to-mid-term ripples in European markets.
What Caused the Meltdown?
As Ryan Flavley, Managing Partner at Silicon Valley-based Restive Ventures, phrases it, SVB's collapse is "an ultimate case of an industry cutting its nose off to spite its face." The meltdown can be seen as the culmination of a large-scale, ill-informed Silicon Valley investor trend fuelled by several powerful market forces.
Over the course of the last three years, the American economy has had a new challenge to tackle - inflation. As a response, the Federal Reserve had been steadily increasing interest rates to a point where the debate shifted from 'Will the interest rate cross 5% in 2023?' to 'How far above 5% will the interest rate land in 2023?'
These increased interest rates,
- Caused the American IPO market to go cold very quickly.
- Led to private funds drying up for Silicon Valley's startups, i.e., SVB's core clientele.
As a result, several startups started withdrawing their deposits to meet their urgent liquidity needs, which in turn caused a cash crunch at the SVB. Consequently, the bank was forced to sell a $21 billion bond portfolio consisting primarily of U.S. treasuries at a $1.8 billion loss. This caused a funding hole the SVB decided to fill by announcing the sale of $2.25 billion of common equity and preferred convertible stock last Thursday. This ultimately spooked investors and clients (who indulged in a mass withdrawal frenzy), causing the fundraising efforts to go bust. Venture Capital firms such as Peter Thiel's Future Fund further advised investors to withdraw their SVB deposits, which served as the final death knell for the SVB.
The Impact of the Meltdown
The FDIC insures deposits up to $250,000 per depositor, per insured bank, and per ownership category. For starters, this means that more than 37,000 SVB customers who had more than that threshold in deposits at the end of 2022 are staring at an uncertain future.
Most of these customers did not have access to their money in SVB for three days following the collapse, causing panic in startups about employees not getting paid.
In the medium and long term, many startups in Europe and the U.S might have to shop around for alternate sources of funding. SVB’s VC arm, SVB Capital, is known to hold several ‘Limited Partner’ positions in prominent investment firms like Sequoia Capital and Accel.
According to their LinkedIn page, "SVB Capital manages assets of 7.5 billion dollars, mainly for third-party 'limited partners', and is one of SVB's core businesses." Several companies on SVB Capital’s roster have invested in European technology companies. Sequoia is, for example, Klarna's largest owner, while Accel and Index Ventures are two of the largest owners of the digital healthcare provider Kry. This is likely to affect the availability of much needed capital for these companies and may force them to look for alternative sources of funding.
Future Outlook for European Markets
While SVB was primarily a U.S.-based lender, its collapse has had an imminent impact on banking worldwide. The meltdown sparked a debate over the resilience of worldwide banking systems, adversely affecting investor confidence in Europe. Since the crash, the European index of banking shares (.SX7P) has fallen 7%, affecting more than 120 billion euros ($126.5 billion) of market value.
However, EU regulators believe that the meltdown is a result of the failure of U.S authorities to enforce regulatory requirements for liquidity. While the regulations are much stricter in the EU, further investigation of SVB’s meltdown could prompt European authorities to implement more stringent regulatory measures on banks. This will directly affect the availability of startup capital in the region.
Takeaways From the SVB Debacle
Because of SVB's overarching focus on just one industry, it always ran the risks associated with an under-diversified portfolio. Any and everyone will tell you that it does not constitute a sound investment strategy and can occasionally be dangerous.
On the other side of the equation, it can also be argued that - as far as practically feasible, both startups and venture capital firms need to spread their deposits across multiple banks and financial institutions to make the most of the $250,000 FDIC deposit insurance limit.
Many startups were at risk of closure before U.S. regulators stepped in to backstop all SVB deposits, prompting criticism of V.C. funds for not advising their portfolio companies to diversify from SVB. With their knowledge of financial intermediaries, V.C. funds should have been aware of the risks.
Where can startups go from here?
The FDIC has created a new bank into which all SVB's deposits have been transferred. Further, as a part of the federal government's intervention program to ensure depositors get their money back, the Treasury Department will provide up to $25 billion from its Exchange Stabilization Fund as a backup.
While these measures solved an imminent liquidity crisis and reassured markets in the short term, there are mid- and long-term risks remaining. In the current scenario, startups should aim to access instant liquidity to refinance their existing SVB loans. Once they find stable funding, these startups can explore alternate funding opportunities that allow them to stay afloat and compete in a changed startup ecosystem where the availability of venture capital and, subsequently, startup valuations may take a severe hit.
One such company that has been helping startups with refinancing is Float.
We are a finance platform committed to supporting as many SVB-affected businesses as possible. We are happy to offer up to three months of loans as instant liquidity for SaaS startups with a subscription business model.
Find out how our entrepreneur financing revolution can work for you!
