How Will the Collapse of Silicon Valley Bank and Signature Bank Impact Investment Activity in the Tech Space?

Steve Socolof:

Sure. Thanks, Alan. It's great to be here. Tech Council Ventures is probably the leading and largest early stage venture fund in New Jersey. The firm's been around since 2000. We are first of all a regional fund, so focused on the mid-Atlantic region as Alan mentioned, which to me means we have a very strong commitment to New Jersey and then surrounding states. So about half our fund is deployed in New Jersey and the rest in surrounding states. We're an early stage generalist fund, so we're typically doing seed and early Series A deals and pretty open sector-wise, although we have a strong emphasis in healthcare, about half our fund is deployed in healthcare and the rest mostly in clean tech and enterprise. We're starting to look more at fintech deals right now, but generally pretty broadly. On the software side, we're looking for deals that are reaching about a million of ARR, thereabouts. On hard tech or deep technology, we're often going in a little bit earlier with maybe a less upfront investment to see how the technology develops and comes to market.

Alan Wink:

Steve, I think a lot of people are interested to hear what's going on in the VC market. We all went through COVID and we're pleasantly surprised that venture capital set records for capital investment, number of transactions, the amount of capital raised, valuations, and then it's changed a little bit. 2022, now in 2023, numbers are way down. I think it's becoming tougher for founders to raise capital today. What's your perspective? What's going on in the market?

Steve Socolof:

I think COVID provided a very short decline in the market. The first part of COVID, it was surprising to me that that lasted about one quarter and then the market roared back into '20 and '21. Those are record-breaking years for funds raised, funds committed, exits, et cetera. So '22 and into '23, the market's overall been way off. I think that's largely driven by economics, macroeconomic factors. Obviously the war in Ukraine started to hit the market early last year, and then the Fed started raising interest rates, which slowed the market. NASDAQ was down 33% last year. So those macroeconomic effects, those market effects come down into the venture market. Fundraising's been way off in '22 and '23 so far and committing capital is down, number of deals are down, so the market's definitely in kind of a pause right now, probably except for a few bright spots that we can talk about.

Alan Wink:

You talk about fundraising, and people I talked to in the industry said fundraising has gotten much tougher. I think that VCs in general are still sitting on a lot of dry powder that's got to find a home, so you could almost expect that activity will continue at pretty high levels in the VC space because of that capital that needs to be deployed, but what happens in the future? If fundraising comes to a halt now, what happens three or four years from now?

Steve Socolof:

Yeah, I think there's a fair amount of dry powder now, but it's definitely down from where it was a couple years ago because fundraising was down last year, it's down into this year. I just saw news this morning that the other TCV, Technology Crossover Ventures, raised about half their target in their latest fund. So, I think we're going to see a pause here for a little while. I think there will be less capital deployed, but I don't know how long this is going to last and I think the market could turn around in the next 12 to 18 months. And in venture, we make investments in deals that could take seven to eight years to come to fruition, so we don't worry too much about the current market environment and this could be a very good time to be investing, and I think the people that are raising right now are pretty excited about opportunities in the market.

Alan Wink:

Steve, I think we can go under the assumption that it's going to be tougher for portfolio companies to raise capital in the future. What advice are you giving your portfolio company management teams as regards to capital, deploying capital, growth, et cetera?

Steve Socolof:

I think Silicon Valley Bank made a very interesting statement right before they went under, which was what they saw was fundraising and investing activity very much down in '22 and going into '23, and their client base of portfolio companies continued to maintain their burn rates without cutting back, and that was resulting in 15 to $20 billion a quarter of drawdown at Silicon Valley Bank. So I think that's the big concern that we have going into this environment, is the effect of limited fundraising. So of course we're telling our companies to be cautious about spending, to be in a lean mode, stretch out runway, and of course, take money when they can.

Alan Wink: 

Interesting. Let's go back to, you mentioned before, valuations. Are you guys seeing a decline in valuations in the early stage space? I know we're seeing it pretty significantly in later stage deals. Are you seeing the same thing in the deals that you guys are looking at putting money into?

Steve Socolof: 

Yeah, I would say limited. And I say that because, number one, our style has always been very valuation-conscious. We've tended to stay out of the markets that have been really bid-up like New York City in our region and Silicon Valley, obviously. So we've always been pretty value-conscious, number one. Number two, the numbers show that there are valuation declines in later stage deals. Series Cs, Ds, et cetera are down about 20% right now over last year, so we are seeing a lot of down rounds there.

The early stage numbers are actually flat to up right now, but the deal count's way down, so there is a [inaudible] to quality. Better deals are getting done just as well as they were getting done before and we're still seeing some valuation upticks at the early stages. Those are overall market numbers. For us, I'd say we're seeing a little bit of that sort of flat to up and down depending on the opportunity. Some of the opportunities that are very exciting are still getting good support and good rounds, and some other deals that appeal to us because value-conscious are probably a little bit more of a value opportunity for us right now.

Alan Wink:

 And what's going to happen to these later stage companies that have raised C and D rounds and at this point, still need capital to get to the next level? They thought about the IPO market, they thought about strategic exits, and now those opportunities have sort of slowed down or don't exist, what happens to them? And it seems like the VCs are really not interested in putting another round of money into the companies unless they can see a real clear path to profitability, positive cash flow and an exit. What happens to those larger, more established tech companies?

Steve Socolof:
I think we'll see a range of different outcomes. First of all, of course, getting lean. I mean, we were seeing layoffs in the tech industry starting with some of the big tech companies late last year, and that has followed through a lot of the tech industries. People are going ahead and taking cost out, so we're seeing people extending runway. We're seeing down rounds happening, and we saw some big write-downs in some of the big investors like Tiger Global and others, I think wrote off $3 billion or something in venture investments, so we're going to see those write-downs. So people raised money, like I said, later rounds are off about 20% right now, so we'll see that. We see some deals being sold and so more aggressive sales processes. And then finally, we'll probably see a few bankruptcies. AeroFarms declared a couple days ago locally, so that's a good example. From what I read, a round didn't come together for them and they declared bankruptcy.

Alan Wink: 

They know their choices. [inaudible] the concept valuations. During the COVID years, a lot of tech companies raised money at really inflated values. And looking, playing Monday morning quarterback, those companies really couldn't justify those valuations today based upon the performance of the last two or three years. What happens to those companies as they go out and raise money? And you mentioned down rounds, so is 2023 going to be the year of the down round? And is a down round necessarily bad for investors and founders?

Steve Socolof:

Yeah. I think in 2021, we had a good momentum market. People were paying top prices. Deals were pretty competitive. Like I said, it really wasn't our style to participate in those kinds of deals. So yeah, now when they need to raise, they may well be looking at down rounds. I think Tribeca Venture capital raised a growth fund recently and announced that they would be happy to be the bad guy doing down rounds for their collaborators in the venture world, so I think it's going to be more common. It's not necessarily a bad thing. I mean, if you invest it at a momentum price, you might be looking at a downtick. That's okay, but companies can still grow into those valuations, number one. Plus number two, a lot of us structure our deals with downside protections. So even though the price of the round might be down, liquidation preferences might be protected, there might be anti-dilution clauses, so the downside won't be as much as the straight-up number might represent-

Alan Wink: 

So I assume that the leverage has switched from the founder to the VC when you start looking at deal terms?

Steve Socolof: 

I think it's more of a buyer's market right now, a little less founder-friendly as we say, and a little bit more looking for protections.

Alan Wink:

I think the one area of venture capital that really concerns me today is the exit market. And maybe it doesn't apply to you at the earlier stages, but certainly for some of the later stage investors, the number of VC back exits has fallen off the charts. The numbers are really low, a reflection of the lack of an IPO market. The SPAC market is gone. With that lack of exit opportunity, how do VCs create liquidity for their LPs and create returns for their fund? What happens?

Steve Socolof:

Well, the exit markets are way down. They were down all of last year. They're down into this year. The IPO market is pretty closed right now, as you said. M&A transactions, which are always the largest part of venture exits, are way down. In the last few years, PE also became an exit path for a lot of venture-backed companies. I think that the PE players are a little bit going back to their knitting with a higher interest rate environment, and so I think they will be down also. But there's probably going to be a pause here, but people are going to still look for M&As, people will probably still look to PE. And the one area that's actually doing more fundraising than ever right now is the secondary market, so we may well see some secondary opportunities in the market.

Alan Wink:  
Do you see the IPO market coming back anytime soon?

Steve Socolof:

I'm not a good predictor of that. There's plenty of bank economists writing about that, so it's hard to predict. But personally, I think some people still worry about recession and a really dire scenario, economically. I don't personally see that. I think we'll see a stronger market for the rest of the year. I do see some banks now raising forecasts on the S&P and NASDAQ over the next few quarters, so I think we'll start to see a little bit of improvement in the market and that could bring back our exit markets over the next, let's call it a year.

Alan Wink:   
You mentioned earlier the collapse of SVB and Signature Bank in the first quarter of '23. Those two events took me totally by surprise. I've worked with SVB for many, many years and it's always been a great bank. Were you surprised when you picked up the newspaper that morning and saw the problems they were having, and the eventual takeover and collapse of those two institutions?

Steve Socolof:

I was very surprised, probably more surprised than I should have been. In retrospect, there were warnings about the bank last December by bank analysts if you go back and read them, but I was surprised on... So, Wednesday night was when SVB started communicating to the markets about its liquidity challenges and put out some proposals for some refinancing and describing what the situation was. I think by Thursday, at least the West Coast VC community, the word of mouth had traveled pretty widely-

Alan Wink: 

Pull all your money out now.

Steve Socolof:

... about $40 billion left the bank on Thursday. I got wind of it Thursday afternoon and spent Thursday evening reading everything I could, reading what SVB was putting out. And Friday morning, I tried to pull my money out, and I was one of about a hundred billion that got into the queue by Friday morning and none of that money got out. The Fed stepped in. They knew that SVB couldn't support those drawdowns and took over the bank. So yeah, I was surprised by what happened. And I sit on the National Venture Capital Association board. The NVCA did an unbelievable job over the weekend working with regulators on making sure that they understood the impact this was going to have, not on the VC community, but on workers in tech companies and on the innovation agenda that the government has been trying to support for the last year or two under the Biden administration. They did a remarkable job and it was great to see the turnaround by Sunday evening when the FDIC and the Fed stepped in and saved the deposits.

Alan Wink:

So when you're looking back, it really was a non-event. There really wasn't a whole lot of fallout from it. Those two institutions were taken over. I guess Silicon Valley Bank was a large provider of venture debt into VC-backed deals. Do you see First Citizens stepping into that role so the availability of venture debt will continue just as it had with SVB prior?

Steve Socolof: 

It's hard to say. I think First Citizens wants to be in this market the way SVB was. I think that's why they stepped up, so they are going to continue to play in that market. We work with SVB as part of First Citizens. I do see them shoring up some processes and some of their credit underwriting, so I think they'll be a little bit more cautious than they have been. I think the interest rate environment right now drives that as well. On the other hand, I think there's been a bit of a diaspora of SVB talent into other banks, so we're starting to see some other banks being interested in this market. Some of them I think are going to figure it out quicker than others who are coming from more traditional bank lending backgrounds, and there's a number of non-bank lenders out there as well. So whether the venture debt market will stay the same or not offer as much as it did before, I can't tell, but there's definitely a lot of lenders out there.

Alan Wink:

Interesting. So what are you seeing in the early stage companies that are coming to you guys for capital? What opportunities are you seeing-

Steve Socolof:   

We're seeing a range. First of all, in the healthcare sector, we're starting to see some healthcare opportunities with the ChatGPT embedded in them, or the GPT embedded in them. For one example, we're looking at something in the radiology space, leveraging that. Still, as I mentioned, climate tech has also continued to be a very strong area. There's a lot of regulatory support, a lot of government funding for climate technology, so we're seeing a lot there, everything from EVs to batteries to decarbonization and other things. General healthcare, we're still seeing a lot of opportunities in therapeutics and diagnostics. We're seeing a lot of opportunities in AI applied to digital health, for example. So, still seeing tremendous different opportunities.

Alan Wink:

Going back to what we said earlier, it becoming more difficult for founders to raise capital today, especially at the early stage, when you hear a pitch, what gets you excited? What makes you want to have that next meeting with that founder or go through the entire deck rather than the first two or three slides? What gets your interest peaked up?

Steve Socolof:

I think for me, it's three things. It's really credible, exciting founders, people that come from the problem they're trying to solve. Secondly, a really exciting story about the opportunity, the size of the opportunity and what they think they can bring to it. And number three, traction. Show me they've got some customers at bay or some signs of making things happen on their own.

Alan Wink:

Do most of the companies you invest in have some level of revenue, even though it might be a small?

Steve Socolof:

Yeah, that's what I was saying earlier. In the software space, we're generally looking for companies that are getting to about a million of ARR, so they've got some real traction, product market fit is proven. In the deep tech, that's a little harder, and so we are investing a little bit in some pre-revenue deep tech companies, but our investments there are more modest typically just to get in and start to see how they're developing the technology and getting over those technical challenges.

Alan Wink:

So let's go to the lightning round. One-word answer, are you going to see it up, down, or remain about the same over the next 18 months, venture capital deployed?

Steve Socolof:

I'm optimistic about the next 18 months. I think we'll come through this downturn this year and we'll see-

Alan Wink:

Up, down, or about the same?

Steve Socolof:

Up.

Alan Wink:

Okay. Fundraising?

Steve Socolof:

Up.

Alan Wink:

Valuations of early stage companies?

Steve Socolof: 

Flat.

Alan Wink:

Valuations of later stage companies?

Steve Socolof:

Flat.

Alan Wink:

IPO activity?

Steve Socolof:

Up.

Alan Wink:

Exits?

Steve Socolof:

Up.

Alan Wink:

Performance of top quartile VCs?

Steve Socolof:

Coming out of a bad year, I think we'll see some upticks getting into next year, 18 months.

Alan Wink: 

You're pretty optimistic, I like that. Steve, I know you meet with a lot of founders who are looking to raise money, and I know the adage in the VC community that sometimes you ask for money, you get advice, sometimes you ask for advice and you get money. Knowing the market that founders are building businesses in today, what are the three points of advice that you'd have for a founder looking to be successful in this environment?

Steve Socolof:

I think we've talked about some of this before, but number one, stay lean. Don't overspend. Extend your runway as much as you can. Two, build as much traction as quickly as you can. And three, probably find some good investment partners that can support you and don't worry too much about the valuation and terms, and get the money in.

Alan Wink:

And I guess, how lean is lean? And when you invest in a company, when Tech Council Ventures invests, how long should that capital take to be fully deployed before it'd have to go out and raise another round?

Steve Socolof:

We're really trying to fund two fundable milestones, so it's nice for the team if they don't have to think about raising for at least 12 to 18 months, if not two years. So sometime in that 12 to 24 months is a good range, but you want to focus on what milestones are going to be achieved in that time, and the team should be very clear about what they're trying to achieve to raise the next round of money. And occasionally, you'll set milestones at an early stage in six months if you really want to see something happen before you put more money into it, so I'd say 12 to 24 normally and maybe shorter if there's some specific milestones we're looking for.

Alan Wink:

And Steve, maybe as we complete this session, I want to thank you so much for participating. Your comments were fabulous. Any final thoughts on this VC market?

Steve Socolof:

I'm really excited about this market. We have a great portfolio that's doing well right now and this is a great time to be investing. There's always apocryphal stories about the best successes come from difficult times, and we're excited about investing in this market.

Alan Wink:

Steve, thank you so much. I think we could have gone on for another couple of hours. This was really insightful, and thanks for participating.

Steve Socolof: 

Thanks, Alan.

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