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Venture Capital Loses Its Relevance After SVB Fiasco

Have we reached the point where startups will bypass VC firms and just go straight to billionaires for funding?

(Bloomberg Opinion/Shuli Ren) — If you are an entrepreneur who specializes in artificial intelligence or rocket launches, chances are, you are not familiar with how banks work, or know what a held-to-maturity portfolio means.

When tech founders go to venture capital, they are not only seeking funding, but also advice. In a way, VC funds function like management consulting companies. Having seen the rise and fall of many firms, they claim to know how businesses can grow. Often, they connect startups with big industry names and teach them how to build operations, such as banking, hiring and layoffs.

The spectacular fall of SVB Financial Group, whose Silicon Valley Bank did business with almost half of all US VC-backed startups, is raising an uncomfortable question: Does venture capital still offer value? Why didn't funds tell their portfolio companies to diversify from SVB?

Before the US regulators stepped in Sunday to backstop all SVB deposits, many startups were at the brink of closure. The Federal Deposit Insurance Corporation only insured up to $250,000, and the vast majority of funds held at SVB far exceeded that. As of the end of last year, at least 39% of SVB's deposits came from early-stage startups. As a result, many were scrambling to arrange last-minute loans to pay their employees, while hedge funds were offering to buy claims on their SVB deposits, at as much as 40% discount.

It's not like SVB was a hidden, unknown risk. Since late November, short sellers have been gradually pushing up their bearish interest in bank stocks, betting that the Federal Reserve's rate hikes were not good news for financial institutions. William Martin, a former hedge fund manager, warned of SVB's balance sheet issues two months before its collapse. If SVB was forced to sell its securities holdings, it would have incurred a $15.9 billion loss, thereby wiping out its entire tangible common equity.

On the deposit side, SVB's client base is too concentrated. If venture capital funding suddenly dries up or there is a bank run, all its clients will withdraw money together.

SVB Q4 2022 Financial HighlightsSVB Q4 2022 Financial Highlights

With this kind of balance sheet and deposit profile, it is worth asking why venture capital allows their portfolio companies to put all their eggs into that one basket.

VC funds, which are ultimately financial intermediaries, should have known better. They routinely dabble in the money world, talking to their investors — ranging from pension to sovereign funds — as well as investment banks, which help take their unicorns to public markets. SVB's collapse and its rippling effect in the startup world is a sign that VC funds have lost their discipline. With so much money flooding into their world, they stopped managing known risks. They became simple pass-throughs, shoveling money from one end to another.

One trend we are seeing is that billionaire family offices are eschewing traditional private equity funds and betting directly on upstart companies. A lot of the world's wealthiest are first-generation entrepreneurs themselves. They still want to be hands-on and may find investing in VC funds too passive.

Wealthy families rely on private equity chart

If this continues, with the fallout from SVB's collapse, traditional VC funds may start to lose their relevance. Startup founders might as well go straight to Jeff Bezos instead.

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