Silicon Valley Bank Collapse Chills Seed Funding

Jonathan Nelson had lined up commitments of $2 million in new funding for his fintech startup, HF.Capital, from two investors last month. He was aiming for $2.5 million and thought securing the rest would be “shallow”.

Then 67 investors refused it. In mid-March, its first investors also withdrew.

Mr. Nelson was initially confused by the cold shoulder. But two days later, when Silicon Valley Bank, the most important bank for start-ups and venture capitalists, collapsed after tech investors and start-ups sparked a stampede. bank, it all made sense.

“I was scratching my head saying, ‘Why did they just ghost? “”, Did he declare. “Then the bank run happened and I was like, ‘Ah, they’re terrified. “”

The same awareness is spreading in the start-up world following the sudden failure of SVB. After a heartbreaking 2022, when easy money for start-ups dried up, leading to shrunken valuations, reduced ambitions and widespread layoffs, many hoped things would bounce back this year. But the collapse of SVB has stoked even more anxiety and terror, which is starting to show up in startup deals across Silicon Valley.

Late Sunday evening, SVB was acquired by First Citizens BancShares. The bankrupt bank’s former parent company, SVB Financial, filed for bankruptcy on March 17 and plans to launch a separate process to sell various units.

Over the past two weeks, as regulators scrambled to find a buyer for SVB, companies that relied on it for lines of credit scrambled to secure a new source of debt. Risk-averse investors have increasingly opted to stay away or are too busy helping shore up existing start-ups to consider new deals. And some start-ups are doing what they can to avoid raising new money so they don’t have to deal with lower valuations, onerous terms and rigorous due diligence.

The result is that a cold environment for tech start-ups has quickly turned colder.

“People are realizing that it’s probably not going to get better,” said Mathias Schilling, an investor at venture capital firm Headline. “It was a big shock to the system.”

He said the bank run that led to SVB’s demise showed how much fear already reigned in the market. Investors wouldn’t have triggered such a panic if they weren’t already nervous, he said.

SVB’s collapse was not directly caused by the tech downturn, and start-ups that banked there won’t lose their deposits since the Treasury Department and Federal Reserve eventually guaranteed all of SVB’s deposits. SVB. But the institution’s implosion came on top of a 61% decline in venture capital funding in the final three months of 2022 from a year earlier, according to PitchBook, which tracks start-ups. Kyle Stanford, an analyst with PitchBook, said he expected SVB’s collapse to “accelerate” the market downturn that was already happening.

“We’ve been in a business downturn for a year now,” he said. “It’s just kind of an additional problem that the market didn’t need.”

In a survey of 870 founders last week by venture capital firm NFX, 59% said the collapse of SVB would make an already difficult fundraising market more difficult. Twenty-two percent said they were worried about not being able to raise funds this year.

Techstars, a start-up investment firm that has backed 3,500 start-ups, advised its companies to call their shareholders for more money before introducing new investors, said Maëlle Gavet, chief executive. of the company. Techstars has also attempted to lower entrepreneurs’ expectations of their company’s value, urging them not to see falling valuations as a failure but as a positive sign that someone is ready to invest in their business.

Ms Gavet said she expected a lot of conversations to take place this summer about whether start-ups should close or sell. “The whole SVB affair has created an increased sense of danger,” she said.

Bijan Salehizadeh, an investor who has stakes in a dozen venture capital funds, said between a quarter and a third of the companies his funds had backed would run out of money in the next six months. He called it the “worst time in recent memory to raise new venture capital funds” and added that he had seen many investors “sitting on their hands” recently because they were nervous.

Ayham Ereksousi planned to raise $4 million for his start-up, Stomio, which offers software to help companies test new products with their customers. But he lowered his expectations. He had been in contact with between six and eight investors who had expressed interest in investing by the end of last year. But in recent weeks, as he tried to raise funds, many either failed to respond or said they had changed their investment strategies.

Now Mr Ereksousi plans to raise less money from his existing investors and return next year for a bigger fundraiser. This year is likely to be a “dud”, he said, and worries about the health of banks are “dropping ice water on the entire funding ecosystem”.

If start-ups cannot raise venture capital funds, few other lifelines are available. Stock market volatility has made initial public offerings of shares virtually impossible, while big tech companies are under antitrust scrutiny and face their own financial pressures.

The SVB offered many start-ups a form of credit that other banks found too risky, as start-ups are usually not profitable. This debt, usually backed by a startup’s venture capital, has helped companies stretch their cash until their next round of funding.

“It’s another source of capital that’s pulling back,” PitchBook analyst Zane Carmean said during a recent webinar for investors titled “Has the Music Stopped?”

Mr. Nelson, the founder of HF.Capital, was previously a venture capitalist and has a portfolio of 75 investments. Before SVB fell, he told those companies that funding could start flowing again in the spring. Now he recommends that they wait until September to raise funds. Those in dire need of cash may need to find a way to become profitable, he said.

This is his plan for HF.Capital. Mr. Nelson wanted to use the $2.5 million to obtain regulatory licenses for a software product that would enable international trading of shares. But with investors on the sidelines, he now plans to “start” the business or expand it using profits rather than outside funding.

“It’s just a brick wall,” he said. “Nobody’s doing checks right now.”