Technology startups funding at a crossroad: Assessing impact of collapse of Silicon Valley Bank and signature bank

The global financial sector witnessed the collapse of two major technology-focused banks – Silicon Valley Bank (SVB) and Signature Bank last week. This has plunged the world into a state of frenzy regarding the true state of the global financial system, as many express the fear that all may not be well.

Although the United States (US) and the United Kingdom (UK) governments have responded swiftly to assure customers of these banks of the pragmatic measures in place to secure their funds, and the public of the resilience of the global financial sector, one cannot help but worry about the impact these collapses will have on startup funding globally, especially for tech-focused ones.

Therefore, the purpose of this article is to assess the contributions of SVB and Signature Bank to tech startup funding and financial service provision over the years and how their collapses will affect these services going forward.

Silicon Valley Bank

Silicon Valley Bank (SVB), one of the largest and leading tech-led banks in the United States was established in 1983 and has been providing among others commercial banking services, venture capital, lending, and funding to tech startups, etc. in the last four decades. It operated primarily from Silicon Valley (the world’s technology hotspot) and had operations in Canada, China, Denmark, Ireland, and the United Kingdom.

Rightly, it can be argued that SVB’s immense growth was attributable to the development of the technology sector following the boost in technological advancements and the resultant proliferation in the demand for digitized services following the outbreak of the Covid-19 pandemic.

A review of SVB’s financial statement for the year 2019 showed that its assets – including loans – tripled from $71 billion at the end of the year 2019 to $220 billion at the end of March 2022. As a leading funder for technology innovations, SVB in recent times has participated in some 835 startup investments and raised over $383.5M for participating tech startups within the last three months prior to its collapse.

Earlier this month, SVB raised through a debt-financing arrangement, an amount of $95 million for “Socure”, a startup focused on creating a predictive analytics platform for digital identity verification for consumers. With operations spanning a period of four decades, it is evidently clear that the quantum of financial support to have been provided by SVB to tech startups and small business ecosystems across the world will be gargantuan.

In the wake of the news of its collapse, some 16 tech and life sciences companies in Europe have disclosed about $190 million in exposure to SVB in the UK and the United States. Similarly in India, over 60 YC-backed Indian startups have more than $250,000 stuck in accounts with the bank and nearly two dozen have more than $1 million tied with it.

SIGNATURE BANK

Established in 2001, Signature Bank offered business and personal banking products and services, particularly in the US. It was a significant lender to the cryptocurrency industry, with almost a quarter of the bank’s deposits coming from the crypto sector.

In 2021, more than 16% of its deposits were sourced from the crypto sector, rising to 30% by February 2023, with $16.5 billion in deposits from digital-asset-related customers. As of the end of December last year, a securities filing revealed that the bank had about $110.4 billion in total assets and $88.6 billion in total deposits.

Its shutdown by regulators is having an industry-wide impact, particularly in the cryptocurrency market. “Circle” a crypto startup currently informed its customers that it could not mint or allow redemption of its USDC stablecoin through Signet after the closure of the bank. In a similar vein, “Coinbase”, another crypto startup which held about $240 million with the bank has indicated to its customers that their use of Signet would need to be confined to banking hours only. Also, “LaBranche” advised its customers who relied on Signet for deposits and withdrawals “outside of banking hours” to rely on more traditional banking methods.

TECH STARTUPS FUNDING GOING FORWARD

While it is assuring that, all is being done by regulators in the US and UK to ensure full access by depositors to their funds, there is heightened concern about the future of tech startup funding following the collapse of these two leading banks which primarily operated to provide funding and other financial services to tech startups.

Going forward, funding for tech startups will be constrained in the following manner:

The creation of a severe funding gap – One of the most significant effects will be the funding gap created by the collapse of the two banking giants in the tech start-up sector. These two banks were key players in providing funding to start-ups in the tech industry. As specialized banks that understood the unique needs of the tech and cryptocurrency industry, they were able to provide tailored solutions and funding options that traditional banks and other financial services could not match. This made SVB and Signature Bank go-to sources for tech start-ups and businesses seeking a one-stop shop for all their financial services and related needs, especially, those in the early stages of development.

Consequently, many start-ups will struggle to secure the funding they need to continue their operations, let alone grow. Reports have suggested that since many startups were unable to retrieve their monies, they have resorted to taking out loans to pay their staff. The continued inability of start-ups to access their money beyond the statutory limits may leave them with no option but to reduce their workforce through layoffs or shut down entirely.

Further, the collapse of the two banks will also reduce available funding for startups on the venture debt market, which has grown in importance as venture capital firms have already dramatically scaled back their investments in the wake of the crisis.

As a result of this funding gap, start-ups will need to diversify their source of funding. This could include angel investors, venture capital firms, or even crowdfunding platforms. However, accessing these alternative sources will be particularly difficult, especially for start-ups engaged in the crypto-currency sector, as these investors would be hesitant in working with such businesses due to the regulatory and legal uncertainties surrounding the sector. More importantly, these sources of alternative funding may not be able to match the scale and scope of funding that SVB and Signature Bank provided or may come with their own set of risks and challenges.

Heightened regulatory scrutiny and oversight – Another implication of the collapse of the two banks is that other banks and financial institutions providing similar services to tech and cryptocurrency sector start-ups will face heightened scrutiny by financial sector regulators. Regulators will now be more vigilant and increase their monitoring activities of other banks and financial institutions providing similar specialised financial services. This increased scrutiny could lead to stricter regulations, higher compliance costs, and greater oversight for the banking sector.

Specifically, the focus will be on potential systemic risks posed to the broader financial system that may arise from the financial services tailored toward the tech industry. The regulators will seek to examine balance sheets, risk management practices, and investment decisions more closely to ensure that they are operating in a safe and sound manner.

Also, regulators may impose strict capital requirements on institutions providing similar specialized financial services to the tech and cryptocurrency industry. This may involve increasing the minimum capital requirements for these institutions or requiring them to hold additional capital buffers to absorb potential losses. The higher capital requirements could limit the ability of these institutions to provide services to the tech industry, potentially impacting the industry’s growth.

Finally, regulators may also consider imposing stricter disclosure requirements on the tech and cryptocurrency sector-based firms themselves. This could involve legally requiring these start-ups to provide more detailed financial information to banks, such as audited financial statements and detailed projections of future performance in order to qualify to secure much-needed funding.

The adoption of Stringent Risk Management Processes – In response to the collapse of the banks, financial institutions focused on the provision of tailored services to the tech and cryptocurrency industry may react by taking measures to institute self-imposed stringent risk management processes. These measures will be necessary to ensure the continued stability of the banking sector. One of the main risk management practices that financial institutions are likely to adopt is thorough and rigorous due diligence processes as well as the consistent review of their liquidity ratio. Banks may need to extensively examine the credit history of potential borrowers and consider other factors to assess their creditworthiness. They may also likely conduct a more extensive analysis of the market conditions and industry trends that may impact start-ups’ ability to repay their loan obligations.

Financial institutions in the affected industries will also seek to strengthen their risk management frameworks by implementing more comprehensive risk monitoring and reporting systems. This will involve assessing the performance of the loans in their portfolio, identifying potential areas of risk, and taking corrective action where necessary. Banks will also be required to report on their risk exposure and provide regular updates to regulators. This will ensure that the financial institutions in these affected industries are operating within acceptable risk parameters and that they are taking proactive steps to manage their risk exposure.

The net effect is that start-ups will be required to fulfil more stringent requirements for accessing funding which will invariably impair the funding success ratios across the tech industry. 

CONCLUSION

Tech startups, the true beneficiaries of the specialized financial services that were provided by SVB and Signature Bank are currently at a crossroads. Their most reliable financial partners – providing funding services among others have collapsed. In their stead, tech startups must respond swiftly and innovatively to deal with the effects of funding gaps, expected tightening of regulatory supervision and oversight, and internal risk response by a few existing banks that provide similar services. The promptings of these effects will be relevant for planning for fundraising going forward by tech startups.

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Cecilia Antwi Kyem is a Trainee Associate at Sustineri Attorneys PRUC and practices in the firm’s Corporate, Governance, and Transactions Group. Cecilia specializes in FinTech and Innovations, Startups/SMEs, Commercial Transactions, Corporate law as well as Dispute Resolution. She welcomes views on this article via [email protected].

Harold Kwabena Fearon is a Trainee Associate at Sustineri Attorneys PRUC with its Corporate, Governance, and Transactions Practice Group, specializing in legal service provision for Startups/SMEs, FinTech, and Innovations. He welcomes views on this article via [email protected].

Source: Ghana News