The collapse of the Silicon Valley Bank is making start-up funding go cold

Jonathan Nelson had pledged $2 million in new funding for his financial technology start-up, HF.Capital, from two investors last month. He was aiming for $2.5 million and thought securing the rest would be “mandatory”.

Then 67 investors turned him down. In mid-March, his original investors also pulled out.

Mr. Nelson was initially confused by the cold shoulder. But two days later, when Silicon Valley Bank, the most prominent bank for startups and venture capital firms, collapsed after tech investors and startups began a bank run, it all made sense.

“I scratched my head and said, ‘Why were they just haunted?'” he said. “Then the bank run happened and I was like ‘Ah, they’re terrified.'”

The same realization ripples through the start-up world after the sudden bankruptcy of the SVB. After a harrowing 2022, as easy money for startups dried up, leading to lowered valuations, lowered ambitions and widespread layoffs, many hoped things would bounce back this year. But the collapse of SVB has fueled even more fear and anxiety, which is beginning to manifest itself in the making of startups all over Silicon Valley.

Late Sunday, SVB was taken over 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 several 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. Investors, wary of risk, have increasingly chosen to stay on the sidelines or are too busy supporting existing start-ups to win new deals. And some young companies are doing what they can to avoid having to raise new financing so they don’t face lower valuations, tough terms and strict due diligence.

As a result, a chilly environment for tech startups has quickly become cooler.

“People are realizing it probably won’t get any better,” said Mathias Schilling, an investor with 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 was already in the market. Investors wouldn’t have caused such a panic if they weren’t already tense, he said.

SVB’s collapse was not directly caused by the technical downturn, and the startups that banked there will not lose their deposits, as the Treasury Department and Federal Reserve eventually guaranteed all of SVB’s deposits. But the institution’s implosion followed a 61 percent decline in venture capital in the last three months of 2022 from a year earlier, according to PitchBook, which tracks startups.

Kyle Stanford, a PitchBook analyst, said he expected SVB’s collapse to “hasten” the market’s downturn already underway.

“We’ve been in a growth slowdown for a year now,” he said. “This is just kind of an extra problem that the market didn’t need.”

In a questionnaire of 870 founders last week by venture capital firm NFX, 59 percent said SVB’s collapse would make an already tough fundraising market more difficult. Twenty-two percent said they were concerned that they would not be able to raise money 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 pitching new investors, said Maëlle Gavet, the company’s CEO. Techstars has also tried to reduce entrepreneurs’ expectations of how much their company is worth, urging them not to view their valuations as a failure, but as a positive sign that someone is willing to invest in their company in the first place.

Ms Gavet said she expected there will be a lot of talk this summer about whether start-ups should close or sell. “The whole SVB thing created a heightened sense of danger,” she said.

Bijan Salehizadeh, an investor who has interests in a dozen venture capital funds, said a quarter to a third of the companies his funds had backed would run out of money in the next six months. He called this “the worst time in recent memory to raise new venture capital funds” and added that he had recently seen many investors “sit on their hands” 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 has adjusted his expectations. He had been in contact with six to eight investors late last year who showed interest in investing. But when he tried to raise money in recent weeks, many did not respond or said they had changed their investment strategies.

Now Mr. Ereksousi is considering raising less money from his existing investors and returning next year for a larger fundraising round. This year is likely to be a “dud,” he said, and concerns about bank health are “dropping ice water on the entire funding ecosystem.”

If startups cannot raise venture capital, there are few other lifelines available. Stock market volatility has made stock IPOs all but impossible, while major tech companies are under antitrust scrutiny and facing financial strains of their own.

The SVB offered many start-ups a form of credit that other banks considered too risky, as the young companies are generally not profitable. That debt, usually backed by venture capital from a start-up, helped companies stretch their cash for their next round of funding.

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

Mr. Nelson, the founder of HF.Capital, was previously a venture capitalist and has a portfolio of 75 investments. Before the fall of the SVB, he told those companies that funding might start flowing again in the spring. Now he recommends waiting until September to raise money. Those in dire need of money may need to figure out a way to become profitable, he said.

That 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 stock trading. But with investors on the sidelines, he now plans to launch or expand the business by using profits rather than external financing.

“It’s just a brick wall,” he said. “No one is writing checks right now.”