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Jon Bradshaw & Peter Harris

on and Peter talk about the hottest topic- SVB Crash. Peter breaks down what led to the crash We look at how exposed were VCs to Silicon Valley Bank?Jon asks Peter to explain Capital calls, and how most VCs only have 2% on hand each timeSilicon Valley bank offered loans to VCs. What will happen moving forward?Will VCs have to increase cash on hand?Are VCs doubling down on prior investments or picking new ones while valuations are correct?

SVB Crash: Why, How and What’s Next!

Jon and Peter talk about the hottest topic- SVB Crash.

  • Peter breaks down what led to the crash 
  • We look at how exposed were VCs to Silicon Valley Bank?
  • Jon asks Peter to explain Capital calls, and how most VCs only have 2% on hand each time
  • Silicon Valley bank offered loans to VCs. What will happen moving forward?
  • Will VCs have to increase cash on hand?
  • Are VCs doubling down on prior investments or picking new ones while valuations are correct?
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Episode Transcript

Jon: We haven't recorded for a little while. Spend about a month or month.
Peter: Yeah, something like that. When that happens, too busy doing important things.
Jon: Peter is busy traveling the world, in case you didn't know.
Peter: I am busy doing non important things.
Jon: Business ventures and.
Peter: Important.
Jon: Things. You had a conference and send in San Diego, right.
Peter: Near Laguna Beach.
Jon: Tell us about.
Peter: It.
Jon: Dana Point before we get in.
Peter: It was cold and rainy and I met with a few companies. Some are interesting, some myself.
Jon: You went out with your students. It's a huge VC conference, actually.
Peter: Not of easy conference. It's an investment banking conference. And most of the attendees are lower like microcap stock companies. So it's everything from like the WWE is publicly traded, but they're not a very big company. So like, they're there.
Jon: So not because.
Peter: There's companies like.
Jon: But you go every year like this is like your event in my mind.
Peter: Carrillo Carrillo Ha. I don't know if Carrillo has publicly traded company. Yeah, this company.
Jon: I don't like them. Okay.
Peter: they do have a playboy. Was there one? One year.
Jon: So this is a fan of the show.
Peter: They tried it.
Jon: But you guys don't do anything in that space that you know. Now, what's your reason for showing up? Because you go every year with your students?
Peter: Well, they do have a private track day or private track part of the conference. So we go to that because we would theoretically fund those companies. In fact, actually, we have we funded to those companies. Yeah, but, you know, it's at the Ritz-Carlton and then Dana Point overlooking the ocean. I mean, it's like a little slice of heaven.
Peter: And for our students, it does the job of like one like just like opening their eyes to opportunities that exist, Right. Getting a peek into the world of the, you know, the fabulously wealthy, if you will.
Jon: Okay.
Peter: And understanding like the inner workings of high finance and being able to, like, see and touch and feel. And there's real value in that. And then, you know, the other piece is that,
Jon: Said you go for more a year, you go for your students.
Peter: No, but like we look at deals there, so we'll, you know, we saw some stuff about okay, we've invested in a few, we invested in a company called EARN stems that we source there. We invested in a company called Omaze Great investment.
Jon: That's where we found amazing that we talked with about them off and on for several years now.
Peter: They Gomez fan.
Jon: Rule well for today's podcast but amazing. If you want to follow us around venture capital firm you can find us on Twitter, Spotify, Apple, whatever. So if you're on one of the platforms and want to discover us somewhere else, like where there whatever's convenient for you. So let's there's been a lot that's happened this year, but in particular, there's the Silicon Valley.
Jon: Silicon Valley Bank issue, and I think everyone's aware of Silicon Valley Bank. But let's maybe, Peter, if you wanna start telling us spy what it how the specific implications to venture capital and to VCs that may not have been the main news.
Peter: So we don't want to cover what happened.
Jon: I assume you can do a quick rundown, but I think everyone has an idea of what happened in the bails. I think they failed. I think the bigger question is what is the implication for startups? What is the implication? And are VCs going to be funding deals in the future? Does this pause causing the pause? Well.
Peter: The thing is, is that at this point, Silicon Valley Bank is totally fine to a certain extent because the the FDIC came in and said, we will, you know, ensure all deposits at any amount. Right. And the FDIC put their own CEO in place. And the CEO is basically like, all right, people, we have three pathways. We either shut this thing down, wind it down, staff the assets, or we get enough deposits back in that we are interesting enough to a potential buyer and we sell and we operate as a subsidiary.
Peter: And by the way, you know, when Silicon Valley Bank was like really taking off in the early 2000, there was another bank called Square Bank. And they were, you know, Square was always a little bit smaller in our CV, but they are both like kind of the, you know, the the the venture banks of Choice and Square got acquired by another big fund not because they failed, but just, you know, that was the normal course of business.
Peter: So it's not, you know, unheard of for large banks or even regional banks to have a venture subsidiary. And then the third option, which is the one that they're really hoping for, is that they get enough deposits back in to continue to operate as a standalone entity. And you know what? The CEOs that is basically like, hey, we are the safest place that you could put your money because we get, you know, insurance on deposits with no max and nobody including, you know, the JPMorgan's and the Wells Fargo's get that that sort of nuts that sort of deal so I think though the big thing that's been impactful here is that, you know, Friday morning,
Peter: everybody woke up and they realized that the money they have in the bank is it's not cash, it's an investment that you're making. Right. And that's why banks pay interest on your savings accounts or they provide a ton of services on your checking accounts that they don't charge for. And essentially what you're doing is you put money in the bank account in the bank, and then the bank is paying you either interest or they're paying you in services, but they're not taking that money that you've given them and they're putting it at risk.
Peter: Right. And I think for the last, frankly, for the last couple of decades, people kind of forgot that that was the case because we haven't had runs on the bank and and even the banks that failed. They you know, it was a fairly like limited number that failed and a very fairly limited number of people that were impacted by those during the last financial crisis.
Peter: You know, it's not like Lehman Brothers had a ton of like, you know, retail deposits in it. So I think that's the first big thing is now everybody is looking at this and saying, I need to have a risk management strategy as it comes to where I put my money. That doesn't directly answer your question is like, what's the impact on venture and so forth.
Peter: but look, you know, rates are going up and so cost of capital is going up and that means that venture debt, the cost of venture debt is going to go up. And with the collapse of Silicon Valley Bank, even though they're still around their supply and deposits and so forth, their depository base is going to be a lot lower no matter how you cut it, because people are going to diversify where they put their money.
Peter: They're also going to be skittish around SVB. Unfortunately, it has a tarnished image at this point, right? I mean, it's kind of like even though they may be the safest, people are going to be nervous about having their money there, so their depository base is down. And that just means there's going to be less money that they can lend to startups.
Peter: and so you've got this double whammy of higher interest rates and less deposits. And so Silicon Valley banks are going to end up lending out less money to startups. Now, all of that said, one of the things that was really interesting is that loans to startups only really represented like 20 to 25% of their asset base. And over 50% of their asset base was for capital call lines, which is kind of interesting.
Peter: And what a capital call line is, is that if you're a venture fund and you say you raise $100 million, well, there's this like misconception that you have $100 million in the bank. and then, you know, as you meet with startups, you draw on that million dollars and invest it. And that's that's really that's.
Jon: What most people thought. I thought that a VC firm would have max up to like 25 or 30%. Yeah. Minus what they've invested or paid in salaries.
Peter: Yeah.
Jon: And for me, the bigger problem that you shared is that number is actually far lower.
Peter: Yeah, usually, I mean, the reality is, is that in many cases that number is actually close to zero. And the reason for that is because you have these things called capital call lines and a capital call line. is a loan made to a venture fund that's designed to do a few things, one of which is allow them to move very quickly.
Peter: And the other is that actually helps boost their returns, their, their IRAs on their fund performance. So the way it does that is when I ask you, like I find a company that I want to invest in, right. We're going to invest $1,000,000, whatever I have to give my limited partners, my investors in my fund. Typically it's about ten days.
Peter: Business notes. In my case, that's ten days. So we give them ten business days or roughly equates to two weeks to get their capital calls in. Right. And so, you know, we're sitting and waiting for two weeks. We can close until we get the money and it takes two weeks right. And then once we get all the money, then, you know, and it kind of comes in over time, then we bundle it all up and we we wired off to the company.
Peter: So even in the cases where you're not using a capital call line, usually you don't have that much money sitting in your bank account before you're wiring it out. The one caveat to that is that you probably are sitting on some cash to pay for salary and overhead and all those things because you wouldn't want to do a capital call every single time you wanted to run payroll.
Peter: Right. And different funds have different strategies around that. Some, you know, they only call it when they make an investment. Others call it every quarter, some call it three. I mean, there's there's like a lot of different ways that they can do it because you don't really want to put a lot of burden on your your investors to constantly be wiring money over.
Peter: Nonetheless, what the capital call line does is it allows you to borrow the money that you need to fund that investment. So you Silicon Valley Bank or others, basically they give you the million dollars on day one, right. And you make the investment. And so that allows you to move quickly. And then, you know, the capital comes in and then once all the capital is in, you pay off the loan and the interest rates are, you know, they're relatively low.
Peter: The banks don't make a lot of money on the interest rates on these loans because, like they're only two week long loans, you know, and but they charge fees. So you have to pay the fee in order to get access to this this line. And yeah, there's some interest and some other fees and that's that's how they make their money there.
Peter: But if you think about it, if you're a bank and you're going to issue a capital call line, you're going to do due diligence on the underlying LP's in the fund. Right. And so if you've got really good institutional investors in your fund, then it's not that risky of an investment to make right or of a loan to make by a CB.
Peter: And the reality is, is that most funds have pretty good, you know, collections from their limited partners, right? So ends up being a relatively low risk loan. And so when you look at Silicon Valley banking, you're like, well, like, you know, over 50% of their loans are these these capital call lines that really are only out there for like a few weeks.
Peter: And they're usually the you know, they're backed by larger institutional investors. That seems pretty low risk, right? So but I guess my point there, though, is that with these well, let me just close the loop on how it uses returns. It's basically one of those things where it's like, well, if I can pull down the loan for $1,000,000 and make the investment and I'm paying a relatively low interest rate for that lower than what my normal cost of capital is, or in other words, lower than what kind of return I need to generate on like dollars that I invest.
Peter: Then there's a little bit of an arbitrage game that you're playing. It only lasts a few weeks, like I said, but you're able to like call capital and pay, I don't know, like 2% interest on that capital you've called even though you've promised and illicitly you've promised your peers that you're going to generate something closer like 20% net IRR or an effective.
Jon: 2% APR, but on a two week basis.
Peter: Yeah, something like that. Okay.
Jon: So like the number is almost minuscule.
Peter: Right? Right. And they, they don't really make the money. So on the loans.
Jon: How will this affect entrepreneurs And later is it deals are going to take longer to close or are is that whether Silicon Valley bank or other regional banks are going to offer similar type of services.
Peter: Dubiously? I actually don't think it's going to impact it that much. I mean, there are a lot of different groups that provide capital call lines. So there are banks that do it there. Firms like Carta, right, where we're an investor that offers capital clients. So there's a lot of places you can get capital lines.
Jon: So basically VCs lose their money. They have a lot of other places they can put their capital to get similar types of services. Yeah, so it shouldn't affect the output that founders have. And that I think the other big takeaway for me is that if this were to happen again, hypothetically and and the federal Reserve weren't to back the bank at that point, yeah, then it's not like VC would dry up for the next two years.
Jon: It's not like a third or half or like let's say let's say a five just rate.
Peter: Is like the money didn't like completely disappear.
Jon: for sure. But it was all.
Peter: Backed by assets. They just that would have had to liquidate the assets and your your risk as you would have only gotten $0.95 on the dollar back, but you would have gotten $0.95. Right.
Jon: Right. But it could be. So the example is we have a few clients for venture backed. Yep. And they called me and they said, John, we had X amount of capital in the bank. We now only think they're going to get to 50 back hypothetically. And I was like, okay, this is a different world. Yeah, how can we help out?
Jon: But then the next thing was, is we have got friends were VCs like you. And I'm like, Man, if you have like because in my mind I thought, Hey, if you have a third of your fund at Silicon Valley Bank. Yeah. Then that money vaporizes. And what you're saying is if, if this situation happens again. So while there's no normal short term or long term effect and if this were to happen again and the after is, you know, the government work to back them, it's not like most of these funds would be losing more than 2% of their of their.
Peter: Due to 10%, you know, of of what they have in the bank.
Jon: Over they have in the bank which.
Peter: Only and usually most funds are only going to have one or 2% in the bank in any given time.
Jon: And my example, my thinking was when this happened is I know a lot of books that have hundred billion plus funds listed under, but our fund, let's say they had a third of it and maybe they spent half, I guess 15 million of their $100 fund. That's like potentially vaporized if the FTC didn't back them now.
Peter: But even if the FDIC did.
Jon: I guess they still.
Peter: Had the assets they were in recovery. Right. But I challenge those. Everybody is running into is they didn't have access to it today. Correct. And so they couldn't run payroll. And that's why I was freaking out.
Jon: But I was looking at it is like what what potentially could happen to venture capital? Could VC dry up for a number of years? Hypothetically. But no, that's not happening.
Peter: That's not happening. And not like they want to get it out. Yeah, it's not like what I look like for Silicon Valley Bank. They're going to contract. They're not going to be the dominant player they were. And ultimately that's going to be a negative for the venture community as a whole.
Jon: Yeah, I'm just bringing up long term things because we, you know, we've known that Silicon Valley Bank has fallen first Republic was in a risky spot. You've got signature bank failed Credit Suisse. So the question was is, is my might is if this cascades what potentially could happen?
Peter: Well, I mean, look, if it cascades, well.
Jon: We don't know. We don't know.
Peter: And more regional banks fall right. Like it could be really damaging. Look, I think at the end of the day, the economy runs on trust. And what's happening is and I think this is important to understand about Silicon Valley Bank. So, I apologize to our listeners if you already understand this, but effectively what happened was Silicon Valley Bank is they if you think about their business, right 2021 was like just an insane year.
Peter: So tons of money flow went into venture funds. Those venture funds put tons of money into startups. The startups took all of that cash and they put it in their bank accounts. Right. And predominantly, you know, Silicon Valley Bank was the beneficiary of all those deposits. And then they borrowed money from Silicon Valley Bank on top of that, right in the form of venture loans.
Peter: But the amount of like venture loans on a relative basis to equity are always much smaller. Right. And so what you had was you had Silicon Valley Bank that was struggling to put all of these deposits to work and companies. And so what they did is they bought these these long term treasuries at relatively low interest rates, right.
Peter: Because they needed to put the money somewhere. And the thought was, look like we'll put them here, even if, you know, let's say rates double or triple. Right. Like we can handle that kind of risk. Like, you know, whatever, we'll be fine. You know, we can manage this and we're going to hold these things until maturity anyways. You know, everything's going to be fine, right?
Peter: There were a lot of decisions made like that in 2021 that made a ton of sense at the time or totally rational. But then fast forward to 2022 and what happened is all of a sudden capital started to dry up and these venture, you know, these companies weren't raising as much money from venture funds anymore because either they couldn't or it was very, very expensive.
Peter: And so they wanted to kick the can down the road and raise later when hopefully valuations would recover. And so they started to burn up all of the money that they had borrowed from Silicon Valley Bank, which, by the way, the money that they borrowed from Silicon Valley Bank got deposited back into the bank. Right. To be loaned out to other thing.
Peter: So like even when Silicon Valley Bank was lending out the money, it created more deposits for them that they then had to put to work. So like this is kind of what's going on. So anyways, the startups all of a sudden they they're like, crap, we need to extend Runway as far as we can and they start burning up cash, right?
Peter: So they're burning up their entire SBA loan. They're not raising money on the same cadence they were before. And even if they did raise money, they're not raising as much as they would have in the past. And pretty soon they start dipping into their other deposits right there, their equity, their equity cash on the balance sheet. And so Silicon Valley Bank, they have to pay out these deposits when they're demanded.
Peter: Right. And pretty soon they start running out of cash and they had to sell off these bonds. Yeah. The problem was, is that interest rates have gone through the roof. And if you understand how bonds are priced, it's basically like, you know, if you if you buy the bond today, you are going to get paid out a certain amount and interest so that by the time you get to the end of the bond period, you will have made some, you know, guaranteed return, you know, 1%, 2%, whatever it might be.
Peter: Well, if you want to sell that same bond like you have two choices, you either hold it to maturity and not lose any money on it, or if rates have gone up, you now have to sell it to somebody else at a low enough price that it implies a higher interest rate. And so Silicon Valley Bank had to sell off these bonds at much lower prices in order to drive to build up enough liquidity to pay out these deposits from start ups.
Peter: They're burning all this cash. And that left them in this like tough spot where all of a sudden they were running low on liquidity, on cash on hand. Right. And they were taking big losses on these treasuries. They were selling and they needed to raise money. And so that's where they went to Goldman Sachs, which ironically, they sold the bonds to Goldman Sachs at a loss.
Peter: And then Goldman was like, well, I'll be recoup by taking an equity infusion. They got that whole equity book filled and they were ready to close. And then the venture is, frankly like we're like, we're worried about Silicon Valley Bank. We think you should. PAUL And that just like blew up and spread like wildfire and the whole thing collapsed.
Peter: The reason I say all of that is because.
Jon: You love the subject.
Peter: I think it's interesting. I think it's fascinating. But what does that mean in terms of like if you're listening and you already knew all that, that's great. But what does it mean for these other regional banks and why is like first Republicans in trouble, right? First Republic is in trouble, and so are a lot of other banks, primarily regional banks that don't have the liquidity base to handle this, because they also we're taking lots and lots of money and deposits.
Peter: Right. Because it wasn't just the venture scene that was like flooded with cash. The whole economy was flooded with cash and people were putting tons of money into the bank. Right. In terms of deposits. And so and these banks lend out enough money. Right. And so a lot of them were also buying treasuries, which those treasuries are now underwater.
Peter: And so the risk it's the risk is that they might fall into the same situation. And First Republic in particular was in trouble because if you looked at the type of depositors they had, they're all super wealthy. And those wealthy individuals can move money really quickly wherever they want, Right. Just like a startup can, you know, And they have a lot of money in these accounts.
Peter: So and so if you pull all that money out really quickly, right, all those deposits, then they could also face a liquidity crunch as well for sure.
Jon: Let's go back to basics, though. Is that okay?
Peter: Yeah.
Jon: So you're saying it won't affect the industry much? What about the venture debt market? I did. I don't.
Peter: Know that. I would say it's not going to affect the industry much. I think it'll still impact it.
Jon: I mean, VCs didn't lose money. Startups didn't lose money. whenever there's banking issues, you have money. You see myself as.
Peter: Your source of capital and that just got like massively dinged.
Jon: Massively leading, but it got brought.
Peter: Back, but it's never going to be bought.
Jon: At all, right? Right. But there are other lending options from banks.
Peter: There are, but many of them, like really understand and how to how to do ventures.
Jon: What's the implications for debt investing? Will chase Bank open or expand their venture that are.
Peter: Probably over time.
Jon: Are there other alternatives than Silicon Valley bank because I don't think deposit is yet there are.
Peter: There are there are there's like bridge bank and in Western Pacific I mean there's a bunch.
Jon: So at that point I think for the most part outside of regular banking issues, the last big subject is venture debt, right? Yeah, because venture debt is largely unique to a Silicon Valley bank more than other types of banks, correct? Right. Right. And that's where the big hit is. Because typically, if you were to raise a $10 million fund or 10 million are $10 million for a startup, you might also have what percentage would be venture debt potentially?
Peter: if you raise how much?
Jon: 10 million.
Peter: I mean, it can rain a few million bucks. A couple million to three, right?
Jon: So that is probably going to be gone short term or significantly reduced or or.
Peter: Significantly more expensive. Yes, more expensive, harder to get. Yeah.
Jon: As a direct result of Silicon Valley Bank. What's happened to it?
Peter: Yes. Well, and the ways it's had on everybody else because now everybody else is like skittish right.
Jon: Like so outside of general market forces, things that are specifically unique to VCs, I'm assuming the one summary is venture debt is much more expensive or harder to get or comes in smaller amounts. Yes. And that's the big from a VCS podcast outside of the whole banking scenario. That should be your takeaway.
Peter: Yeah.
Jon: And some people argue that venture does just bad anyways. And that's a that's topic for another day. But would that, would that be your summary too? The main takeaway is this is what we need to watch. This is still have other places where they can bank. You know, there's a there might be a two week delay in getting funds.
Jon: But the real issue is the venture debt issue that's 100% unique to Silicon Valley Bank and that Silicon Valley Bank is a large provider.
Peter: I think I think that's fair to an extent, but I do think it's worth understanding that if that we have like a major run on regional banks and a collapse, there, it will impact it'll have like catastrophic impact on venture.
Jon: Yeah, correct. I mean any.
Peter: But is going to have to have a catastrophic attack on everybody. Right.
Jon: I was looking specifically was what is unique to the venture space VC still have their money in companies that have recently gotten investment got their money back. What are the big dynamics they're going to change? You know, if a VC takes two weeks longer to deploy capital, it's painful but not earth shattering, right? It's like, yeah, it's a it's single digit percentage, you know, time increase.
Peter: But it's not going to make a huge difference on that.
Jon: It just is primarily venture debt, which is largely unique to Silicon Valley. I think other banks, they'll do it, but Silicon Valley bank providers, 50% of it.
Peter: I mean, they're a very large player. I don't know the exact numbers.
Jon: I don't know the numbers. Soon we'll get someone who can like give us numbers and build in real time.
Peter: What's the number?
Jon: Come on, Jackie, What's the number? Jackie or Sam or whatever or whatever name we pay.
Peter: You have a new name, Sam.
Jon: All right.
Peter: All right. Yeah. There you go. All right. Silicon Valley Bank spent an interesting couple of weeks. We'll see what happens to the rest.
Jon: Of the cells down for everyone. I know a lot of people lost jobs. It's been very stressful. So I know a lot a.
Peter: Lot of people lost a lot of money. Right, Because Silicon Valley Bank was worth quite a bit and all of that equity value is evaporated overnight.
Jon: The meantime, I went to Bitcoin.
Peter: Went to Bitcoin. So that's true. Bitcoin is up. I don't know that the money went to bitcoin, but bitcoin itself.
Jon: Okay, well, thanks for watching guys. This is the venture capital podcast. Go to venture capital firm filings to Spotify, Apple, YouTube, our Slack group, which we're going to get more active in.
Peter: Apparently.
Jon: Apparently. All right. Thanks, guys.
Peter: Thank you.