Home Business The demise of Silicon Valley Bank sharpens the spigot on $30 billion in venture capital

The demise of Silicon Valley Bank sharpens the spigot on $30 billion in venture capital

by Ana Lopez
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Startups borrowed so they wouldn’t have to give up their equity. After the collapse of market leader SVB, they can expect higher rates and fewer deals in the near future.

in 2017, When David Rabie first launched Tovala, which combines a smart oven with a food delivery service, the idea seemed a little crazy. Then the pandemic came and the idea took off. He has raised about $100 million for the Chicago-based company and has also borrowed a few million dollars in venture capital from Silicon Valley Bank as an alternative to selling parts of the company. That enabled him to expand Tovala, which now employs 350 people and has three food facilities in Illinois and Utah.

“SVB lent us money when the company was very unprofitable and in its early stages,” says Rabie businessroundups.org. “A lot would have been different if SVB had not lent us the money at Series A [venture-funding round]. There were no other banks willing to do that.”

Rabie is just one of many entrepreneurs who raised venture capital from Silicon Valley Bank – the bankrupt bank that was the largest issuer – as debt financing for venture-backed startups increased. According to the Pitchbook-NVCA Monitor, venture capital use will reach $32 billion by 2022, more than quadrupling from $7.5 billion in 2012. SVB’s share of that issuance was $6.7 billion last year. Rates ranged from 7% to 12%, plus warrants that allowed the lender to acquire a small equity stake in the company.

Since the collapse of Silicon Valley Bank last weekend, founders and investors have been asking a lot of questions about what might happen to their existing debt. As panic spread during the bank run, founders who had taken out venture capital from SVB worried that if they took their money out of the bank, they could be in breach of loan covenants that require them to keep cash there. Now some are wondering who could buy the debt — private equity firms, including Apollo Global Management, would be interested — and end up with a minority stake in their company. “It’s kind of awkward that you’re sending investor updates to a mystery player,” said Matt Michaelson, founder and CEO of Smalls, a high-end cat food start-up that raised venture capital with SVB.

More broadly, there is the question of what happens to this market, which has been growing rapidly but has remained largely under the radar at a time of rising interest rates and investor skittishness. “Venture debt is going to get more expensive,” said Jeff Housenbold, former Shutterfly CEO and venture capitalist at SoftBank, who now runs his own investment firm, Honor Ventures. “Companies that are vulnerable will not be able to take on debt.”

On Tuesday, Tim Mayopoulos, the new CEO of Silicon Valley Bridge Bank, the name of the entity operating under the FDIC’s trusteeship, said in a memo that the bank would “give new loans and fully honor existing credit facilities.”

That allayed some immediate concerns, but it doesn’t answer the longer term questions.

To understand how cheap this money once was, we need to look at the case of Rajat Bhageria, founder and CEO of Chef Robotics. He closed a $2 million debt facility with SVB in December 2021 at an interest rate just 50 percentage points above prime, which was then 3.25% – an extraordinarily low cost of capital for a robotics startup. “Clearly prime has changed quite a bit,” he says. “At the time it was extremely low, and it was like, ‘How in the world are we getting this?'”

For a robotics company, where the cost of capital is high, risk debt has helped a lot, and Bhageria still sees it as positive even though the prime rate has risen to 7.75%, increasing its cost of financing. “There are a lot of complaints about venture capital,” he says. “They’re marketing it as a ‘runway extension'” — the time the company can continue to operate without raising new funds — “but it’s not entirely true because you’ll soon have big monthly debt payments.”

Michaelson, the CEO of cat food, has raised approximately $30 million in equity and has a $4 million debt facility with SVB. He says he is reconsidering his company’s financing in the wake of the SVB’s bankruptcy. When the bank run started, he says, “we got a lot of pressure from our investors to get our money out.” But he was afraid the loans would default. When he finally tried to get money, the transfers failed due to the surge in demand. Although that is now in the past, the experience has made him think.

“I’m worried,” he says. “We talk about, ‘Are we refinancing the debt somewhere else?’ The question is what the debt market is doing and will such debt be available?The wind is blowing in the direction of less available debt, and the people who are less likely to have that debt are likely to feel the pressure.

Michaelson says he recently heard of a founder with a startup in a similar stage who got a term sheet for venture capital at an interest rate of 13.5%. “That’s much higher than what we’re looking at,” he says. “At a certain interest rate, it is no longer so attractive. You’re not just comparing debt to debt, but debt to equity. Depending on how valuations develop in the venture markets, it will become less competitive.”

Since the fall of the SVB, so have non-bank lenders looking for more market share in the venture capital market. “While SVB had a concentration of startups, it wasn’t so concentrated that you couldn’t find an alternative anywhere,” said Arjun Kapur, managing partner at Forecast Labs, a startup studio that is part of Comcast NBCUniversal.

The big question going forward, as always when it comes to financing, is risk and cost. “It’s expensive right now because people are risk averse,” says Housenbold. “So there will be less venture capital in the beginning, which means founders will take more dilution. The venture capitalists will make more money and the founders will own less of the company.”

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