Navigating The Venture Debt Market Post-SVB Collapse

A major bank collapse post-GFC (global financial crisis) once seemed as far-fetched as a global pandemic; yet, both have somehow come true in the past five years. Now, following not one but two major bank collapses of Silicon Valley Bank (SVB) and Credit Suisse in March 2023, the lending landscape has changed dramatically. In particular, the venture debt landscape was left with an incredible void without SVB, the dominant player in that specialized market. Many believed that non-bank venture lenders would emerge as the true winners of SVB’s collapse, stealing market share from traditional banks. One year later, there has been no true winner. The banks and non-bank lenders have managed to coexist, while the potential for a new large-scale, yet niche, entity like SVB seems a thing of the past.

The Rise and Fall of Silicon Valley Bank

In the VC ecosystem, SVB's unparalleled importance extended beyond just financial support. The bank served as a trusted partner and advisor to many startups, providing not only capital but also strategic guidance and networking opportunities. Leading up to its downfall, SVB had cultivated an extensive portfolio of loans primarily targeting private, VC-backed companies in sectors like technology, life sciences, and healthcare; this portfolio surged to $5.5 billion by 2021. At the time of its collapse, SVB's venture debt holdings represented between 60% and 70% of the entire venture debt market. As noted by the Financial Times, SVB's collapse left a “gaping hole” in the venture debt market. The bank's relationships with VCs and its ability to structure deals that aligned with the growth trajectories of startups made it a linchpin in the ecosystem.

However, that all came to a crashing end, as SVB collapsed in March 2023, an event that sent shockwaves through the venture debt market. The collapse was primarily triggered by a combination of factors, including a rapid increase in interest rates, a concentrated, niche client base, and poor risk management practices. As the Federal Reserve raised interest rates to combat inflation, SVB's long-term bond investments, which were made during a period of low interest rates, lost significant value. This created a liquidity crunch for the bank, leading to a classic bank run and SVB's ultimate demise. 

Music To The Ears of Non-Bank Lenders?

The collapse of SVB created a large void in the venture debt market which non-bank lenders were quick to fill. These private lending institutions capitalized on the sudden demand for alternative financing sources in this niche. Their agility and willingness to take on higher risk profiles allowed them to provide immediate support to startups and growth-stage companies in need of capital.

Unlike traditional banks, which often have stringent lending criteria and regulatory constraints, private lenders could tailor their offerings to meet the specific needs of venture-backed companies. This adaptability made them an attractive option for businesses seeking quick and customized funding solutions in the uncertain post-SVB landscape.

Furthermore, another key differentiating factor is that non-bank lenders typically raise LP capital to offer debt in contrast to traditional banks which leverage customer deposits to issue loans. This allowed non-bank lenders to benefit from the influx of capital from investors looking to diversify their portfolios amidst the instability caused by SVB's collapse. With traditional banks facing increased scrutiny and regulatory pressures, private lending institutions attracted significant interest from institutional investors seeking higher yields and exposure to the high-growth potential of venture-backed companies. This exponential increase of capital allowed non-bank lenders to expand their lending capacity and further solidify their position in the market.

Resurgence of Traditional Banks

The honeymoon period was dampened, however, in the third quarter of 2023, as public equities began to recover and the Fed acquired a more dovish stance on interest rates. This created the perfect storm for traditional banks to switch from “risk-off” to “risk-on” lending and re-enter the venture debt market. As the terms suggest, “risk-on” lending involves extending credit with higher tolerance for borrower risk due to optimistic market conditions, while risk off lending entails more cautious credit practices due to perceived or actual market volatility and uncertainty.

In turn, the banks squeezed out some non-bank lenders who feared the risks associated with a continued high interest rate environment. Simultaneously, this led to venture debt deal value peaking in Q3 2023, as illustrated in the graph below.

Figure I: Venture Debt Deal Value and Deal Count Since 2019

Another key factor contributing to the resurgence of traditional banks is the unwavering trust in the banking system. In particular, 70% of consumers continued to trust traditional banks to “do what is right,” according to a report from business intelligence company Morning Consult; this is in contrast to non-traditional banks for which only 47% of respondents believed they would “do what is right.”

Balanced Coexistence Creates Stability For Venture Debt Ecosystem

This dynamic shift has created a symbiotic environment where both institutional and non-institutional lenders can thrive. While private credit funds and non-bank lenders offer the flexibility and rapid decision-making that startups often need, traditional banks bring stability and experience to the table. This duality ensures that companies have access to a spectrum of funding options tailored to their specific needs and growth trajectories. 

Moreover, collaborations between venture debt providers and equity investors have enhanced the market's resilience. By working together, these entities have enabled companies to optimize their capital structures and access a broader array of resources, fostering sustained growth and innovation.

Ultimately, though there is no one entity that has been able to replace SVB and its dominance in the market, the natural solution that has emerged over the past 16 months or so is arguably more sustainable. Both traditional banks and non-bank lenders offer unique debt solutions and, as such, the coexistence between the two types of entities creates a diversified, stable, and productive market for venture debt.