The startup scene has gone through quite the ordeal these past few weeks, due to the events with Silicon Valley Bank and a few other affected banks. And while we’ve made it out of the immediate fire, there are quite a few questions still left around what happens now and what we should start thinking about for the future.
We sat down with Ben Hron, Partner at Brown Rudnick LLP, to gauge his thoughts and what advice he’d offer to the startup community on what the next steps should be for both now and the future.
Startup Boston (SB): What are some of the best practices companies should think about in lieu of recent events with Silicon Valley Bank (SVB)?
Ben Hron (BH): Some of it is still in flux, there’s a lot we don’t know and the situation is developing quickly - just a couple of weeks ago the bank was shut-down and two days later the FDIC guaranteed all deposits, so I do think both companies and borrowers are getting a lot of whiplash right now.
The good news is that the immediate crisis has somewhat abated, but companies need to take a serious look at not just their banking relationship but also any loans they may have had with SVB or another bank that was affected - and consider what would happen if another crisis occurred.
Right now we’re being told that all SVB loans and letters of credit are going to be honored, so there may not be an immediate need for a change. However, we don’t know if third parties will continue to accept letters of credit from SVB or the other banks that have been flagged. So I would recommend that startups do the following:
If you’re in a position to move money and not contractually obligated to keep your deposits at a failed bank (more on that in a moment), look into establishing one or more additional banking relationships and consider moving at least a portion of deposits to other banks.
If you need or decide to leave money in the bank that you’re with, consider having your money swept into something like a money market fund where it would be held with a third party and technically not a bank asset.
If you have a line of credit with SVB, consider whether you should try to refinance the loan with a different bank.
These are all things startups should start to evaluate in the near term because with interest rates continuing to rise, at least for now, we could see more banks run into trouble.
SB: Legally speaking, is there anything startups should be aware of when it comes to replacing any lines of credits or other outstanding loans?
BH: It’s not going to be simple. The SVB bridge bank is honoring those loans and, as such, there are contractual obligations still at play.
You may be able to refinance the loan with a different bank, but there are costs associated with doing that. Also, you may not receive better terms, or terms that are as good as your existing loan terms, at another bank.
Even if you are not planning to refinance your loan, you should take a hard look at the terms of your loan and consider if you should approach your bank about making changes. For example: SVB, like many other banks, typically required that borrowers also have their principal deposit account at SVB which precluded borrowers from spreading deposits across multiple banks and led to many companies not having access to any of their cash when SVB collapsed. If a startup has a loan with this type of restriction, I strongly recommend approaching the lender about allowing a portion of funds, for instance, funds in excess of FDIC deposit insurance limits, to be held at another bank. This would help you create some form of redundancy should something else happen in the future.
SB: What should you keep in mind, on a legal side, if you are strapped for cash during this time and need to make payroll?
BH: Paying employees is a statutory obligation, with potential personal liability to directors and officers if not paid on time. In some states, including Massachusetts, the officers and directors at the company can be held personally liable if the company fails to make payroll. One of the reasons the timing of the SVB failure was a huge problem for many companies, and why the government acted so quickly to make funds available to depositors, was that it came so close to a time of the month when many companies had to fund payroll. If possible, startups should try to have sufficient funds put aside - at a separate bank or in highly liquid investments, to cover at least one payroll cycle in order to buy themselves time in case their primary account becomes unavailable.
SB: What should founders, the executive team and their startup’s board start thinking about during this time?
BH: For boards and management teams, it’s important to ensure you aren’t caught unprepared. Companies should start taking steps to create a plan and processes that they can put in motion should a similar situation occur again.
This would include thinking about:
Putting money set aside to fund at least one payroll cycle;
Creating a plan for reducing payroll quickly through layoffs or furloughs;
Creating a plan for reducing other expenses quickly; and
Establishing a line of credit and identifying other sources of emergency funds.
SB: What types of mid to long term impacts do you think will follow in lieu of the recent SVB events?
BH: SVB wasn’t just a deposit institution; for so many startups it was the lender as well. And while there are other venture debt lenders and traditional lenders out there, at least in the near term they won’t be able to fill the gaping hole in the market left by SVB’s collapse. Many of those institutions won’t be willing to lend on terms that are startup-friendly, and those that are won’t be able to replace the volume of loans SVB originated.
Regardless whether your startup is looking to refinance an SVB loan with another bank or establish a new line of credit, you need to start exploring your options sooner rather than later. These conversations with other banks are going to take longer, not just because of the challenging global economic environment, but also because there will be more startups calling them then there used to be.
SB: Lastly, as a startup community, what do you think our next step should be?
BH: Nobody set out to create a bank run at SVB. Investors trying to protect their own portfolio companies told startups to pull their money out. But word spreads quickly and that is how we ended up with more than $40 Billion being withdrawn from the bank in one day. This arguably could have been prevented with better communication. I’d like to see the National Venture Capital Association or another industry group set up a taskforce to plan for these types of contingencies so when the next crisis arises there is some coordination amongst the venture capitalists that hopefully helps to mitigate the fallout rather than making it worse.
About the Author: Ben Hron is a Partner at BrownRudnick, a law firm that represents companies from both the public and private corporations, multinational Fortune 100 businesses and start-up enterprises.