BY Mark Sanchez Thursday, April 06, 2023 09:38am
Silicon Valley Bank’s epic collapse further tightens the environment for venture capital-backed companies planning to raise additional and larger capital rounds in the near future, local investors say.
The Santa Clara, Calif.-based bank’s failure leaves a gaping hole in the ability of companies seeking later-stage investments to secure debt financing that often accompanies venture capital rounds beyond the seed and early stages. That potentially may make fundraising for growth capital an even more difficult proposition for companies.
The fundraising environment was already getting harder a year ago when interest rates began to rise and concerns picked up about a potential recession, said Tim Streit, co-founder and managing partner at Grand Rapids-based Grand Ventures. Tighter credit for venture capital deals following Silicon Valley Bank’s collapse will put liquidity “at an even higher premium,” although there remains “a ton” of dry powder in the venture capital in the U.S. that firms are seeking to deploy after record-breaking years in 2021 and 2022, Streit said.
“For portfolio companies, liquidity is going to be a little harder to find,” he said. “Credit’s going to tighten, but our overall view is this isn’t the end of venture or the end of the world. Well-performing companies that are growing and addressing big markets will continue to get funded and will continue to be a great source of returns for investors. I think there’s going to be a little bit of a reset in terms of short-term liquidity.”
Between two funds, Grand Ventures has $70 million in assets under management and recently completed successful follow-on capital rounds for three portfolio companies, Streit said. The firm invests in early-stage investments in tech companies in the Midwest involved in business enterprise software for advanced manufacturing, agriculture and food, transportation and mobility, and other industries.
About half of Grand Ventures’ portfolio companies have some form of venture debt with Silicon Valley Bank, Signature Bank in New York that failed March 12, or through other banks, Streit said.
‘Almost perfect storm’
SVB’s collapse came on top of higher interest rates, a softening economy and predictions for a moderate to mild recession in the second half, as well as the resulting lower valuations and poor exit environment for investors that have been driving down venture deal flow.
The situation creates an “almost perfect storm” for venture capital and a “jitteriness in the market,” said Dale Grogan, managing partner of Grand Rapids-based Michigan Capital Network that manages four venture capital funds and five angel investor groups across the state.
Venture capital-backed companies seeking larger, later-stage capital rounds of Series B or later will feel the fallout the most, “because there’s nobody to fill that gap right now” for venture debt, Grogan said. About $3 million to $5 million in venture debt that, for example, may have been part of a $20 million capital round in the past is “just off the table right now,” he said.
That gap will affect how much companies seeking growth capital can raise from prospective investors.
“I think (capital) raises will get smaller, I think they will get harder, and with the lack of debt financing, that’s going to squeeze the market,” Grogan said.
After the disruption caused by Silicon Valley Bank’s failure, and the collapse days later of Signature Bank, both of which were subsequently sold, “people are still somewhat cautious,” said Jeff Wesley, executive director at Red Cedar Ventures, the early-stage venture investment subsidiary of the Michigan State University Research Foundation in East Lansing.
“Generally, when you’re in our space, we like consistency. That’s always our best world. When there’s volatility that happens, either with the economy or events like this, they kind of impact who’s funding, how much people are funding and how much gets done,” Wesley said. “Put that with the other economic factors going on, they tend to freeze people a little bit for some period of time.”
However, at the early stages where Red Cedar Ventures invests, Wesley expects to remain busy in the coming months, as venture capital investments by firms that focus on later-stage rounds ease.
Market adjustments
SVB, which federal and California banking regulators seized on March 10, was a major provider of debt financing for venture capital deals. The collapse “puts more pressure on a venture market that was already reeling from the slowdown in financing seen over the past year,” according to an analysis on SVB’s collapse by PitchBook Data Inc.
SVB in 2022 issued $6.7 billion of venture debt, which accounted for 9 percent of its loan portfolio, PitchBook reported. The failed bank had another $41.3 billion in lines of credit to venture capital and private equity firms.
Grogan doubts any large banks will enter the market anytime soon to provide debt financing for venture deals, at least until they get more certainty about the economy and they’re “convinced things are going in an upward direction.”
“I think it’s going to go unfilled for a while,” he said.
Streit at Grand Ventures cast a little more optimistic tone. He believes that other lenders will eventually emerge to fill the market void created by the collapse of both Silicon Valley Bank and Signature Bank, both of which were subsequently sold.
“There are still other healthy banks out there that continue to reach out,” Streit said. “The market will adjust.”
Even if they do, venture-backed portfolio companies will still face tighter standards when seeking credit to accompany a capital round.
Given the tighter credit environment, investors say they’ve been advising portfolio companies to conserve cash.
“We’re counseling everybody, manage your burn,” Grogan said. “Let’s kick out the things that are not going to generate near-term value or near-term revenue.”
Grogan cites as an example PhotoniCare, a portfolio company that developed a medical scope so doctors can more precisely diagnose middle ear infections in children. The company had been preparing to develop the next generation version of the device.
“We’re saying, ‘let’s just hold on that. We don’t need to invest that money this next year because we have a viable version one, so let’s think about scaling back and preserving cash so that when terms get better and cash becomes more available, no one’s going to suffer as much dilution,” Grogan said.
About 10 percent of Red Cedar Ventures’150 portfolio companies were affected by the Silicon Valley Bank collapse, Wesley said.
Back to normal?
Now that the situation has calmed down from the chaotic immediate aftermath of the bank’s failure, Red Cedar Ventures also has focused on ensuring that portfolio companies “maximize their cashflow and extend their runway whenever they can” for the economic conditions that may lie ahead, Wesley said.
“We’re probably looking at bigger macro issues now,” he said. “Obviously, if things get more challenging with the economy, we want to make sure all of our companies have good bandwidth and enough cash on hand. You kind of want to make sure that’s in a good place in terms of cashflow.”
Silicon Valley Bank’s failure threw venture-backed companies who used the bank for deposits and banking services into turmoil for a few days until the FDIC said it would cover all deposits.
About a third of Grand Ventures’ 25 portfolio companies, including one that had more than $100 million on deposit, had exposure to the bank’s collapse, Streit said.
Several portfolio companies, especially fintechs, also had lines of credit with the bank or venture capital debt with Silicon Valley Bank, Streit said. The March 27 acquisition of $72 billion in Silicon Valley Bank’s deposits and loans by North Carolina-based First Citizens generated a “collective sigh of relief” within the venture capital industry, he said.
After federal regulators acted to protect all deposits, stabilize the industry and find buyers for both Silicon Valley and Signature, “I’d say we’re in the early days of getting back to normal, which will be kind of a new normal,” Streit said.
Both Streit and Grogan expect a more investor-friendly market for the next year or two, as valuations continue to decline amid the softer economy and high interest rates.
Despite the two big bank failures, Steven Doorn, director of portfolio management at trust bank Legacy Trust in Grand Rapids who’s worked in the financial services industry for 30 years, said he’s not worried about the about the U.S. banking system.
“I don’t think there’s anything broadly worrisome,” Doorn said. “From a banking and financial stability perspective, I don’t think this is a widespread systemic problem. That’s not to say there aren’t banks that are being caught offsides.”