8 Tips for Evaluating Startup Risk Post-SVB
Now that the federal government has stepped in to guarantee deposits for Silicon Valley Bank (SVB) customers following the bank’s failure, the dust is finally settling for founders after a panic-filled weekend. While many startup leaders and their investors are breathing a sigh of relief, the crisis highlighted several key areas that private companies need to evaluate more closely to mitigate long-term systemic financial risk in a still-shaky economic environment.
The Hum Capital team has been in close contact with entrepreneurs on our platform, and we’re publishing the guidance we’ve shared with them more widely to support as many startup teams as possible moving forward.
For startup leaders looking to map their risk exposure but unsure where to start, here are eight potential risk areas we recommend digging into with your team to help navigate volatility in the coming months.
1) Banking Relationships
After living through the last week, you likely understand this risk area best, but there are still some fundamental considerations to keep in mind around your banking relationships.
Make sure you know where you bank and what your uninsured deposit balance is. Do your best to spread assets between multiple banks to mitigate your risk. In general, the larger the bank, the better. With the Fed’s emergency lending program, small bank deposits are protected, but with major share price declines, people are distracted and there can still be operational issues in getting your money out if you need it.
From a financial risk perspective, you cannot have too many banks, but it can be difficult to manage a large number of banking relationships at once. One way to get the best of both worlds is to ask your bank to spread your deposits across FDIC-insured banks using the Intrafi system.
2) Payroll Vendors & Credit Card Providers
Most founders don’t think about the mechanics of payroll processing, but you should know who you use for payroll and where your payroll vendor banks.
To help decide whether you are comfortable with your current configuration, ask your payroll provider for the full list of their banking relationships, and whether they have policies around using systems like Intrafi to ensure deposits are protected during the payroll process.
If your payroll provider is not able to provide details on their banking relationships, that’s a red flag, and you should consider moving to a different vendor.
Similar to payroll, ask your credit card providers about their banking partners and policies to double check that you feel comfortable with your credit-issuing bank.
- Chart: Payroll App Market Share (2021) – Apps Run The World
3) Undrawn Credit Facilities
If you have a revolving or delayed draw credit facility with a bank that is in trouble, it is likely that you will not be able to draw additional capital even if the bank says it is making new loans.
If your refinancing institution has not been shut down by the federal government, you don’t need to race to refinance your loan, but if it has, you should immediately look into refinancing your loan with an institution that can fulfill its commitment.
Founders should lean toward upfront financing rather than delayed draw loans because you could end up investing $50K in legal fees on a delayed draw option just to learn you can’t make your second or third draws on the credit facility. That is a bad use of both time and legal budget.
Borrowing from banks will be the lowest cost solution and is well worth considering, but you should also look at private credit funds as an alternative. Private credit funds’ capital comes from binding fund subscriptions from limited partners (LPs) such as sovereign wealth, family office, insurance, banking, and pension fund shareholders. Because of the binding nature of the commitments and the diversification of the limited partner base, private credit fund capital behaves differently than bank deposits. Namely, it is difficult for there to be a “run” on these kinds of funds. This kind of capital typically costs more, but you’ll be paying for greater certainty, which may be worth it during volatile economic conditions.
Hum Capital can help on this front: our platform routes entrepreneurs to all of the relevant lenders for your refinancing situation, making it easy to compare funds, banks, insurance and other sources of private credit capital all in one place.
- Raising Debt: Hum Capital’s Guide to Non-Dilutive Financing [ebook] – Hum Capital
- Fundraising 101: Hum Capital’s Guide to Raising Capital [ebook] – Hum Capital
If you are counting on additional investment from any investor, make sure you check in with them to understand their financial position. This means understanding where they bank and whether they are facing any defaults from their limited partners. In general, the more investor conversations you can have at once, the better to diversify your risk.
The main question to ask in these investor conversations is “what kind of LPs do you have?” If you hear “I have one major LP and it’s a bank,” you may decide that is riskier than an investor saying “we have 10 LPs and they are diversified across family offices, pension, insurance, sovereign wealth and bank capital.”
LP defaults are rare because the terms on defaulting LPs are onerous compared to the terms imposed on a depositor for withdrawing their capital. LPs would have to pay a penalty, but there is no discouragement on depositors against withdrawing capital from a bank. This is why fund-based credit is often more certain than bank-based credit.
While uncommon, founders should make sure to cultivate strong relationships with multiple investors because if LP defaults happen more often, diversifying your capital sources is the best way to overcome them.
- The consequences of LP defaults due to capital calls – Private Equity Wire
5) Brokerage Accounts
Startups often have money market funds or treasury portfolios that are technically held within a brokerage subsidiary of their bank. Securities in brokerage accounts are protected up to $500,000 by the Securities Investor Protection Corporation (SIPC). This is different from the FDIC, and non-bank brokerages are not protected by the current Fed lending program.
If you are a startup that owns $10M of treasuries via a brokerage subsidiary of a major bank, you have $9.5M of uninsured assets, and zero FDIC protection. Within reason, spread your brokerage assets between a handful of large brokerages.
- FDIC Insurance FAQs – Charles Schwab
Startups should avoid making vendor prepayments at this stage, even if you’ll save 5%. When you make a prepayment, you lose control over your cash, and in the current environment, founders should focus on guarding as much cash as they possibly can.
7) Mission-Critical Vendors
Make a list of the vendors you need to prioritize to keep your business running, such as cloud providers or payment processors. For each mission critical vendor, we recommend identifying a list of backup vendor options, and working with your team to make a list of the steps required to switch vendors should the need arise. This will help you see clearly where you may run into friction.
If a mission critical vendor is impossible to switch away from, building a contingency plan now before you need to switch is a good idea. If a vendor is easy to switch away from, there’s no need to do too much work on this upfront.
Some insurers (e.g. health, auto, D&O, E&O) may be exposed to the same underlying issue that impacted SVB. We recommend mapping out where you are insured.
Like bank insolvency, insurance insolvency can mean you don’t get the money you expect when you need it. Unlike banks, however, making insurance claims is a rare event and an insurer’s inability to pay those claims does not halt business operations in the same way a banking issue does. For example, a health insurer may stop paying employee medical bills or your D&O insurer may not be there for you in a shareholders suit. These are important scenarios to plan around by understanding the solvency of your insurance partners but they won’t cause your business to grind to a halt and thus you have some more time to think this through.
Hum will be providing facts around insurer solvency in the coming weeks, so look out for more here. At the end of the day, you are counting on your insurers to pay claims when you need them.
Take a Breath and Move Forward
This has been a week of financial whiplash for many founders, but as the overall economic situation improves, remember there are actions you can take now to avoid more headaches in the future. Hum will be sharing more helpful insights for startups evaluating their financial positions in the coming days, and you can reach out to our team for more support if you need it.