Silicon Valley Mayhem

By Jerome Lau, Marketing Director at King’s Commercial Awareness Society

Silicon Valley Bank, the pioneer and linchpin of the venture debt market, collapsed on March 2, 2023. It was renowned for providing alternative sources of funding for start-ups, where its prices were known for being “extremely competitive”.

This has left many start-up founders anxious about the availability of venture debt and the potential pressure this could have on existing loans, which could significantly impact valuations or hasten company collapses amid an already tough funding environment.

Venture debt has become an increasingly popular option for start-ups to raise funds with the sharp decline in venture dealmaking.  The advantages it has brought to the table include the avoidance of taking a much lower valuation, where company founders entered into debt-focused deals such as bridge loans, structured equity, convertible notes, participating bonds and generous liquidation preferences.

Another major advantage which venture debt brought was its ability to prevent equity stake dissolution, which allowed investors to have better control over their business by having ownership of larger equity stakes. The demise of SVB, which has been a go-to for the tech sector for decades, is a wake-up call to the risk of start-ups which heavily rely on venture debt.

According to data from Preqin, SVB was behind more than 60% of all deals in the California venture debt market in 2023 and was responsible for roughly a tenth of all venture debt issued across the US so far in this year. The bank’s collapse will likely result in a reduction of venture debt available to start-ups, and the remaining options may come with worse terms and higher risk overall.

In the US last year, the venture debt market was the solution to the shrinking pool of available venture capital. Total debt issuance was $32bn, in line with 2021, even as venture capital fell sharply from $345bn in 2021 to $238bn, according to data from PitchBook. Access to venture debt has been a way for start-ups to buy some extra time or put cash in the bank for a rainy day.

The demand for venture debt has been increasing in European markets as well, where debt issuance to European tech companies doubled to €30.5bn in 2022 compared to 2021, according to a report by GP Bullhound, a tech investment and advisory firm.

What caused the crash was the hiking of interest rates to combat inflation, which caused SVB’s portfolio to rapidly lose value. This created a chain reaction with customers withdrawing their deposits just as rapidly, leading to the company selling its assets at big losses to address the sudden shortage of cash on hand, with the bank announcing its collapse within the next 48 hours after doing so.

Primarily, start-ups that arranged facilities with SVB but never drew down on them would be the most heavily affected, and there is much uncertainty as to whether these facilities will still be available, and the possibility of refinancing them.

Thankfully, for the UK at least, the acquisition of SVB by HSBC seeks to re-stabilise the sector via the re-stabilisation of SVB UK, addressing the fears of losing ‘suspended’ capital, minimising disruption to the country’s tech sector and supporting confidence in the financial system.

Ideally, this crash will require similar intervention in other regions of the world for stability to be reinstated in the market sector, but SVB’s sombre tale may prove to be a cautionary tale for investors and future entrepreneurs in the tech industry.