Mon 03/13/2023 19:05 PM
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After a turbulent few days during which investors and depositors initiated withdrawals of $42 billion from Silicon Valley Bank, the bank’s holding company, SVB Financial Group, was placed into Federal Deposit Insurance Corp. (FDIC) receivership last Friday, March 10, by California’s financial regulator, the Department of Financial Protection and Innovation.

Earlier today, HSBC announced that it will buy Silicon Valley Bank UK Ltd. for £1. The announcement sparked a debate about the fate of Silicon Valley Bank’s U.S. assets after the FDIC announced it is seeking a sale of those assets to pay back depositors. Both strategic and private equity firms have entered the fray as potential buyers, as reported. Should the sale process fail, SVB, the former holding company, will likely file for bankruptcy.

While the collapse of Silicon Valley Bank will be felt most acutely by early-stage and venture-funded startups, its rapid demise will bring both uncertainty and opportunities to investors beyond the Bay Area, according to market participants. Over the short term, investors say, deposits and funding will shift to more established banks, which will likely lend at rates less favorable to startups than entities like Silicon Valley Bank, which sought to keep assets below $250 billion as a means of attenuating regulatory scrutiny. Bank holdings of mortgage-backed securities will likely come under heightened scrutiny by investors given the losses the asset class has suffered in the wake of the Fed’s rate hikes, with smaller and regional bank stability to be a particular point of focus, they noted.

One immediate consequence of SVB’s collapse will be felt in the high-yield and leveraged loan primary markets. New issuance and refinancings, already muted after the record volumes of 2020 and 2021, are likely to largely vanish over the near term, especially among financial services and technology names. The bank’s collapse has highlighted an even greater need for better liquidity covenants in deals and more careful considerations of PIK versus cash options in debt documents after many years of issuer-friendly debt documents devoid of maintenance covenants, they said.

Silicon Valley Bank’s website highlights that it holds “relationships with more than 50% of all venture backed companies in the US” and that “44% of U.S. venture-backed technology and healthcare IPOs YTD banked with SVB.” Sources noted earlier that startup deposits held at SVB tended to be used to fund business development, making them less sticky than those held by consumer-focused banks.

Silicon Valley Bank was primarily focused on lending to what are essentially cash-burning companies, sources noted. The bank’s modus operandi was to lend in exchange for stock options or equity instruments in venture capital-backed businesses, they said, noting that approximately a third of the bank’s profit last year came from exercising these warrants. Venture capital firms and their portfolio companies were also encouraged to keep cash accounts with the banks, which suggests that close to 45% of the Bay Area venture capital market was bankrolled by the bank, the sources said.

Recoveries for potential buyers, investors or rescuers will depend on the extent to which loans guaranteed by cash-burning companies can be monetized, sources said. A buyer like HSBC is likely to take a more friendly approach given this represents an opportunity for the commercial bank to build relationships with such VC-backed industries as technology and life sciences, they added.

An overlooked factor is the role the bank played in mentoring companies that started from scratch and were guided toward higher valuations, which banks like HSBC or Goldman Sachs may struggle to replicate, sources noted. “SVB had the ‘SVB-way’ when it came to managing relationships and it garnered them deep connections with the startup space,” one venture lender said. Large institutions may be less willing to maintain relationships with startups during periods of market turbulence, and the management teams of startups may be wary of lenders who do not understand the “growth over profit” mindset the way that SVB did.

Silicon Valley Bank’s demise will create temporary gaps in the debt financing market for startups and VC-based entities in the United States and Europe, with some lenders already seeing a huge increase in former SVB clients seeking new facilities to fund growth plans and operations. Many small companies had assumed that SVB would be available to provide capital, and its absence provides an opportunity for private lenders with experience in lending to cash flow-negative companies, as larger lenders will likely be unwilling to engage with riskier early-growth companies. The bank’s collapse could leave a gap of as much as $16 billion in annual recurring revenue, or ARR, lending, sources say, which represents a considerable opportunity for private credit.

The failure will cause larger institutions to be more risk averse in the short term so a large void could emerge in backing Series A companies up to unicorn status, sources said. Post-Series C companies or companies looking to complete a merger or acquisition that depended on Silicon Valley Bank for funding will also scramble to find alternative sources of financing, thereby opening up opportunities for private credit funds with an appetite for lending to cash flow-negative companies or other institutions willing to lend on the back of ARR, sources said.

--Geoff Burrows, James Holloway, Luca Rossi, Harvard Zhang
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