2023: Annus Horribilis for Venture Capital

The Outlook

The rapid demise of Silicon Valley Bank(SVB) from a position of seeming invincibility portends an “Annus Horribilis” not just for the U.S. venture capital industry but also for Canada’s. SVB’s collapse into federal receivership together with a hard-nosed U.S. Federal Reserve Bank determined to wrestle stubborn inflation down to its 2% target level mean that investment volumes, fundraising and industry performance will all suffer declines. This 1-2 punch means that 2023 will be exceedingly difficult, 2024 might see the first stirrings of recovery and it will not be until 2025 before the situation returns to a new normal.

The New Reality

As an asset class, venture capital had been largely insulated from the ebbs and flows of exogenous factors and its fate and fortunes had been more the result of the push and pull of traditional supply and demand. The new reality is that the wider world is intruding on venture capital to an extent that had formerly been unimaginable – thus the shock, dismay and utter disbelief on the part of industry participants when SVB went from hero to zero in a millisecond. That wider world first made its presence known with higher inflation, that prompted central banks to raise interest rates, that in turn led to P/E multiple compressions in publicly traded tech stocks that then migrated to private capital markets. In addition, that wider world has shut off the prospects of investment arrangements with states that are perceived as hostile, particularly China with its massive market and savings as well as Russia and Saudi Arabia. That wider world has also put venture capital, as well as other investment classes, smack in the middle of the culture wars pitting ‘woke capitalism’ against the forces of ‘ethical investing’(including DEI and ESG priorities that have been advocated by some political authorities).

Meanwhile, in Canada

The old adage to the effect that when the U.S. sneezes, then Canada gets a cold also applies to the current situation facing venture capital, despite some initial brave language that appeared from industry participants.

First, Canada is overly dependent on the import of foreign venture capital, mainly from the U.S. The most recent data compiled by CPE Analytics for 2022 show that U.S. venture capitalists accounted for between 45 and 50% of all venture investments in Canada. Given the dominant position in venture formerly enjoyed by SVB (wherein according to the bank about 50% of all US-based venture capital backed firms had dealings with SVB), it is likely that U.S. funds will concentrate on propping up their own domestic portfolio companies to the detriment of foreign ones. Again, the new neo-mercantilist geopolitics will intrude with the U.S. political system as it acts to prioritize salvaging innovative, American startup companies before any others.

Second, Canada’s own venture capital funds have had substantial investments(equity and debt) in U.S. companies. It can be reasonably assumed that many will have had dealings with SVB as will a considerable number of tech firms and for these firms the short-term outlook appears quite murky, perhaps even at ‘saving the furniture’ levels. Thus, one firm, Acuity Ads of Toronto has already said that it has $55 million on deposit at SVB, 90% of its cash, and has halted trading in its stock.
Third, with SVB’s operations in Canada similarly in limbo, the future portends a smaller number of venture debt providers, thereby reducing the choice available to funds and firms. There have already been reports of financial vultures swooping down on existing SVB clients – and SVB’s secured lending portfolio doubled in size from $212 million in 2021 to $435 million last year. These raids of the top-credit quality borrowers will continue, short of the whole portfolio being bought up by another existing and likely Canadian, entity. All-in-all, a considerable amount of uncertainty in this part of the market seems likely.

While industry observers discount the possibility of financial sector contagion, with SVB’s difficulties spreading to other banks, the contagion has already spread to the venture capital and tech sectors in other countries, including the UK and Israel. Governments, including Canada’s and the UK’s, are reaching out to get a handle on the exposure of their funds and firms to SVB while across the board dire fears for the future of the innovation economy are being expressed.

The Myth of Invincibility – Shredded

The SVB disaster has laid bare several popular preconceptions of Silicon Valley and its denizens that have been widely held by the industry itself, startup firms and governments, namely:

  • The appetite for risk. Leading venture capitalists pulled $45 billion out of SVB at the first sign of trouble. So much for risk appetite.
  • The herd mentality. So much for original thinking and going across the grain.
  • Long-term thinking. So much for working with longstanding business partners (like SVB) for the long term. Short-termism rules is the message.
  • Above all, the myth of Silicon Valley invincibility, of endless onwards and upwards gravity-defying performance and of exceptionalism shredded– in less than 48 hours.

Richard Rémillard

Richard Rémillard is President of Rémillard Consulting Group (RCG), a unique, Ottawa-based, bilingual consulting firm specializing in providing private sector, government & trade association clients with creative, research-grounded solutions to business issues and public policies involving the Canadian financial services industry. For more information: rremillard@bellnet.ca

Image by Enrique Meseguer from Pixabay

Disclaimer: The views expressed herein are those of the authors; they do not necessarily reflect the views of Private Capital Journal and CPE Media & Data Company.