Brett Hillard, 13 march 2023
Silicon Valley Bank (SIVB) is an important service provider to alternatives managers and its recent closure and takeover by the Federal Deposit Insurance Corporation (FDIC) will likely have long-lasting impacts to the alternative fund ecosystem. Based on the latest SEC ADV filings for registered private capital managers, SIVB is listed as a service provider for nearly 1000 managers overseeing funds with nearly $900 billion in gross asset value.[1]One should note that this data only represents registered managers in private capital. There could be other unregistered managers in private capital as well as registered managers of hedge funds not represented. There are also some cross currents with the gross asset value given the nature of master funds and feeder funds.
Despite the imperfectness of the data, SIVB is material to the private capital space, especially in venture capital. Publicly traded private capital managers sharply underperformed the market March 9 and March 10th, and firms with material relationships with SIVB underperformed to a greater extent[2]. In our view, there are several important impacts to private capital managers and private funds as a result of the SVIB news.
It is reasonable to assume that private capital managers strive for efficiency with service providers and may use SIVB for GP operating accounts and subscription lines, as well as for fund accounts. Larger GPs are likely to have more access to liquidity through various means, compared to smaller GPs, and will be able to weather this dislocation with less disruption. A joint announcement by the Fed, FDIC and Treasury indicated that all deposits (insured and uninsured) at SIVB will be made available to customers on March 13, 2023. This likely eliminates near-term liquidity issues for GPs and portfolio companies that banked with SIVB. SIVB was also a material provider of subscription lines of credit. Funds will have to set up new arrangements or change capital call cadence. With less capital availability in the space, pricing may increase. GPs will have to navigate tradeoffs with higher costs of borrowing.
Given the integration of SIVB in the venture capital ecosystem, we believe SIVB’s failure, along with pressure on comparable banks, will continue to put further strain on capital availability for venture-backed companies. Startups require reliable access to capital as they seek to mature to generate cash flows. SIVB was a leading provider of venture debt. Other providers may not be able to fill the void, as many rely on raising capital from outside LPs vs. SIVB’s reliance on deposits. If sentiment and markdowns continue, allocators may continue to decelerate capital flows to the venture ecosystem.
Longer-term, we believe there could be a trend for GPs to work with systematically important financial institutions to mitigate counter-party risk. This may result in less favorable terms, but gaining exposure to implicit federal backstops likely will come with a cost. Second, GPs will be more mindful in sweeping excess cash to Government and Treasury money market funds.
Third, GPs need to carefully evaluate counter-party diversification. For example, there may be situations that come to light in which the GP used SIVB, many of the portfolio companies had exposure to SIVB with deposits and loans, and the founders of portfolio companies used SIVB for banking, borrowing and wealth management. Operational and investment due diligence providers will likely emphasize counter-party diversification on a peer-through basis going forward.
Lastly, provisions may be added to fund documents that outline what happens when capital calls or distributions get stuck in the financial piping. Provisions, such as what counts as uncalled capital and how preferred returns are calculated, could be under the microscope.
The systemic and market implications of the failure of Silicon Valley Bank are important to consider. As passionate investment professionals, we certainly have been following the latest updates and market action. However, our focus is bottom-up, trying to identify alternative strategies that have the potential to generate attractive, differentiating returns while controlling risks. We believe we have an edge in alternative manager selection and providing wealth managers efficiencies in allocating to alternatives. For more information on how GLASfunds approaches alternative manager selection and allocation, get in touch with our team today.
[1] Data provided publicly by Caste Hall, an operational due diligence provider. Castle Hall’s DiligenceExpress platform, derived data from most recent ADV filings
[2] Stocks considered include BX, APO, CG, ARES, OWL, KKR, STEP, HLNE, TPG
