Over the last couple of days, two more critical players in venture and fintech ran into trouble: First Republic Bank and Cross River Bank. Our view: fintech is about to require A LOT more knowledge about the "Fin".
The big headline, of course, was that First Republic bank was seized by the FDIC and then sold to JPMorgan Chase. While not as central of a financial institution to fintech (or venture) as SVB, the bank was still a critical player in the tech ecosystem. Given the complexity of acquisitions of this scale, it is unlikely that we'll see significant changes in day-to-day operations in the near term. However, longer term, the failure of FRB, SVB and Signature, signals either the demise of—or at least a serious interruption to—the relationship-dependent and industry-specific banking that helped to power the tech ecosystem's growth. While there has been a great degree of political criticism of relationship banking over the last few weeks, a lot of this criticism is disingenuous. The fact is, relationship banking is the dominant form of business banking across almost every industry in the U.S., and it makes sense why it is: providing capital to any industry requires a degree of intimate knowledge about that industry.Together, SVB and FRB were the venture capital industry's banks. And losing both of those banks is bad.
Consequences could include medium- to long-term reduction in VC fund liquidity, with all but the largest funds unable to access the short term capital call lines that enabled some of the massive and turbocharged deal making we saw over the last couple of years. While reducing the velocity of “hype” deals may not be all bad, this latest blow comes at a time of depressed investment and capital scarcity generally. All three banks, but especially SVB and FRB, excelled at understanding the participants, risks, and business models that enabled this type of lending. It's not clear that their successor institutions will continue to invest in the people, industry expertise, and capabilities that powered these products. We also expect to see less access to venture debt, the underwriting of which is also highly relational. Most of this debt has been provided to medium- and late-stage growth companies, which were already under tremendous valuation stress. The tightening of these credit markets is sure to create continued downward pressure on valuations and continue to contribute to an overall slow investment cycle.
The second big development since last week was the recently announced enforcement action against Cross River Bank. While the bank has stated that they don't expect it to impact their growth, it will almost certainly impact their ability to work closely with new fintech companies. The order requires the bank to step up their oversight of existing third-parties (which includes fintech firms) and dramatically limits the bank's ability to add new relationships. Along with the Fed's investigation of their oversight of SVB, the FDIC's investigation of their oversight of Signature, and calls in Congress for investigation into the regulators, we can expect even greater attention from regulators towards sponsor banks. This dynamic will create more challenges and delays for startups that need access to banking services to support their products.
For leaders of fintech firms, especially ones that work closely with bank partners, this is the time to focus on those relationships and, potentially, build new ones. To the extent you're aware of compliance and operational issues that could create issues with bank partners, prioritize addressing these issues. Moreover, make sure your policies and procedures are buttoned up, as this is the first piece of information a bank and/or regulator typically looks at as they gauge the current state of operations. Banks will prioritize the fintechs that are generating income and represent low compliance risk.
If your plan includes venture debt, start modeling scenarios that assume you lose access to this debt. Even if that risk seems remote, it's always good to be prepared. Finally, regardless of your reliance on bank partners, compliance dependencies—or even funding sources—the one thing the last couple of months has taught us all is to be prepared for the risk we know about and stay nimble to avoid the risks we don't.
Perhaps that last point is the most important, because it plays to the advantage of startups generally. Stay lean, pay attention to the market, and move fast. There is still a ton of opportunity out there for the taking.