Silicon Valley Bust

The dominant story of the last month, especially in tech, has been the demise of Silicon Valley Bank. The story is very well documented (see this NPR article for a good summary), but we want to discuss how this impacts the Venture Capital and Startup world.

The reality is that most of SVB's clients were Venture Capital funds Startups, because of this, 93% of their deposits exceeded the FDIC insured threshold of $250k. This concentration of large depositors in a tight knit industry allowed the bank run to occur with such startling speed (VC's affinity for Twitter didn't help the matter). So while SVB's high value clientele led to their downfall, how are these VCs and startups going to be impacted going forward?

For one, they may find other banks are not as willing to meet their every need. Historically, traditional banks have tended to shy away from lending to startups as their risk profile might not make sense in their loan portfolio. SVB shifted the narrative. For years, the bank offered products specifically designed for the venture ecosystem such as discounted rates on loans ranging from venture debt to the financing of VC capital calls, even cheap mortgages for high value VCs. The bank had great relationships, many built through offering these premium services in order to get a foot in the door at a venture fund's many portfolio companies.

This worked. The portfolio companies would bank with SVB because their investors recommended it and they could even raise capital at a reasonable price, without giving up any equity. According to Pitchbook, SVB worked with more than 2,000 currently operating, privately held, venture backed companies. That made up $6.7B in venture debt held by the bank, more than 20% of all venture debt held in 2022 per Forbes. The bank worked with countless other companies, and chances are any major tech IPO in the past few decades banked with SVB.

Why this matters: Why can't Startups just move to another bank? Well, like their VC clients, SVB took risks. They gave sweetheart deals to funds with promise of getting involved with portfolio companies, and lent to startups that traditional banks would deem too risky. Especially with interest rates on the rise, companies (and VCs) will find it harder to access capital at attractive rates. This will lead to more companies either raising equity at lower valuations ("down rounds") or even failure if they are unable to find a banking partner willing to lend at a reasonable price point.

A section where we provide helpful tips for anyone with stock options or shares at private companies.

A popular device used by startups is the NSO Extension. Basically, companies can choose to extend the 90-day ISO exercise window for any employee, the catch is the options must convert into NSOs.

We will cover more on the differences between ISOs and NSOs another time, but for more info head here.

Some companies offer this to all employees but extensions are most commonly found during a layoff (most recently during COVID and again over the past few months). Extensions may feel like a great perk, and a very accommodating offer from companies (during tough times, they definitely are), but they aren’t always a saving grace. To reiterate: it does not always make sense to take an NSO Extension.

The first important thing to understand is that ISOs have preferential tax treatment to NSOs in that they are taxed via AMT, rather than as ordinary income.

The next pivotal item is the length of the extension. By rule, an NSO extension can go no longer than 10 years past the original grant date. The popular term used by most companies (as far as ESO has seen) is 2 years beyond the original expiration date.

Assuming you have left the company (thus triggering 90 day ISO expiration), the decision comes down to: 1) Can you afford the exercise today? 2) Will you owe AMT when exercising your ISOs? 3) Do you believe the company will exit before the extension is up?

All of this also assumes you believe in the company’s future (if not you shouldn’t exercise either way, but may as well take the extension so you can decide on a later date).

If you absolutely cannot afford to exercise or take the risk of exercising: take the extension. Though it could make sense to work with ESO fund your exercise!

If you will not owe AMT, it is worth considering exercising now and rejecting the extension offer. You will never have a cheaper exercise than just your strike price. Chances are the second you switch to NSOs, you will owe taxes upon exercise.

If you worked at a short term IPO candidate (like Databricks), and receive a lengthy extension, you can reasonably bet the company will go public before the extension is up. This means you can exercise a public stock, and sell shares to cover your cost later on. If you don’t think your company is exiting in the near term, just know: the extension will only push your need to exercise down the road. It is likely cheaper to exercise ISOs today than NSOs down the line. That being said, if you don’t have the ability to take the risk of exercising or are not confident in the company, an extension can buy you time to either come up with the funds or see how the company pans out.

Financing your option exercise can be expensive and a require a large capital outlay. Feel free to reach out to us to discuss your options for partnering with ESO to exercise your options risk-free.

The ESO Fund does not provide legal, financial, or tax advice.

March Layoffs Continue To Be Elevated

March layoffs were in line with February, as the tech space continues to undergo restructuring as a result of the current economic cycle. Layoffs this month were led by Meta once again, who let go of another 10,000 employees. Amazon has hit their work force with a third round of layoffs as well, bringing their total laid off since November to 27,000.

Why this matters: Layoffs do not appear to be going away or cooling any time soon, and as a new group of workers will be trying to enter the workforce this May after they graduate, competition for top tech internships and full time positions will be fierce. It appears that the stabilization of this environment will be closely tied to this economic climate finally stabilizing

Brought to you via layoffs.fyi

The graph below displays the ratio of buyers vs sellers for a given month on the private secondary market. Months with more buyers than sellers are displayed in green while months with more sellers than buyers are displayed in red. All data pulled from Zanbato, the below list does not imply completed transactions, simply intent to either buy or sell shares.

Public Multiples Check-in: "Yesterday's Price is not Today's Price"

Declines in multiples are continuing to soften as we move out of comparing current state to 2021 during the startup boom. The sector that saw the largest year over year decline for March was Healthtech, which is down 38% from a year prior. This is followed by Enterprise SaaS down 35% and Real Estate down 28%. We have yet to see multiples come out of the red since we started this newsletter in November.

Why this matters: The Fed's continued fight against inflation through interest rate hikes is going to keep continued pressure on multiples. However, with the recent rate hike being smaller than previous ones, as well as the instability in the banking sector, the Fed may pivot from their rate raising strategy. However, until that pivot happens, we expect multiples to continue to be depressed.

March's Top Ten:

1. Coming in at number one for our top 10 for the month and surprising absolutely no one, Silicon Valley Bank collapsed after Twitter fueled a bank run. It was a sad day for VC, and time will tell if another bank is able to step up and fill the shoes that SVB is leaving behind. Fintechs might find an opportunity here, as Brex did when it saw an influx of deposits before the bank collapsed and offered an emergency bridge credit line to customers impacted.

2. Stripe completed it’s $6.5 billion raise at a $50 billion valuation to help Stripe employees cover tax obligations related to pending expiration of restricted stock units. The raise will also fund a new stock tender offer for current and former employees.

3. TikTok’s future in the U.S. is uncertain as law makers this past month grilled TikTok’s CEO about potential Chinese influence over the platform. TikTok’s parent company, ByteDance, was most recently valued at $20 billion. Investors in ByteDance include Sequoia, Tiger, and Fidelity.

4. In the midst of the SVB collapse, Rippling was able to raise $500m in Series B funding at a $11.25b valuation. The round was a initially a result of customer funds being locked at SVB, but once the FDIC announced deposits were guaranteed, Rippling has indicated they will use the fresh capital to continue to focus on their customers and build great products. Greekoaks led the round.

5. The Fed announced a 25 basis point interest rate hike this past month, slowing from the 75 basis point hike enacted in late 2022. The hike comes after the failure of SVB, and uncertain environment in the banking world as a result.

6. Ever since ChatGPT dropped, everyone is going crazy over A.I., and investors are clamoring to get their money deployed in the space. This interest in A.I. has overtaken the previous darling of Silicon Valley: the Metaverse. In 2022, Metaverse funding was $2 billion compared to generative AI at $612.8 million. In the first quarter of VC funding for 2023, this has flipped, and Metaverse funding trailed generative AI funding $586.7 million to $2.3 billion.

7. China’s exit market is heating up, fueled further by Alibaba splitting into six groups, and most of these units will be heading toward IPO.

8. Global M&A activity for the month shrank to the lowest levels in more than a decade, as rising interest rates and continued fears of recession have made dealmaking more difficult. M&A volumes for the first quarter were down 48% to $575.1 billion as of March 30 compared to $1.1 trillion during the same period last year.

9. Adept AI, a startup training AI to use existing software and APIs, raised $350M in a Series B round. The round was lead by General Catalyst and Spark Capital.

10. Adept AI wasn't the only AI investment for Spark Capital this month, as it led Anthropic's latest funding round. Anthropic raised $300M, bringing its valuation to $4.1 billion. Anthropic is focused on AI safety and building more reliable and steerable systems that provide more predictable results.

Why this matters: Clearly AI is stealing the show in the VC space right now. It will be interesting in the next couple of months (and years for that matter) to see the impact the AI surge has on other startups, and what tasks it begins to make obsolete. Additionally, the question remains if OpenAI will continue to keep the spotlight, or if other startups will be able to develop better products. As with the internet, we believe that for every job AI will replace, it will create countless new opportunities.

Startups that are still hiring!

• Verkada

• Canva

• Grafana Labs

• Databricks

• Remote

• Apollo.io

• Notion

• Klaviyo

• 1Password

Open positions are per the company's website.