Today, around 4 million people work at venture-backed startups in the United States. Another 12 million work at companies funded by private equity. But as capital becomes increasingly expensive with every federal interest rate hike, these companies may struggle to access the cash they need to maintain steady operations — much less the funding they want for growth and expansion.
As a result, according to a statement by Morgan Stanley, many startups may struggle to see 2024. In the wake of Silicon Valley Bank’s collapse, banking regulators are looking at ways to tighten lending standards, increase regulations and oversight, and more closely guide the growth of banks and financial institutions — including those that serve small businesses and startups. And that means the life-giving capital these institutions offer is likely to become harder to access.
As the cost of capital for banks increases, startups are feeling the pinch
In the same report, Morgan Stanley pointed out that credit lines with less than a 10% interest rate are becoming nearly impossible to qualify for. Not only is credit becoming more expensive for the banks that offer it — causing them to pass that extra cost on to customers — closer oversight means these banks must be even more choosy about the businesses they lend to.
Technology companies, which are often considered more risky than traditional companies with physical products or simple services, may be deemed too volatile to back. For banks with strict rules and high standards, stability, profitability, and product market fit are more important than ever. But early- to mid-stage startups don’t always have the ability or resources to prioritize all three — and when growth is fast and resources are tight, profitability may be the first to take the hit.
Unless startups learn to adapt, many may fold
Silicon Valley Bank was known for stepping in during tough times. From tech companies that couldn’t make payroll, to startups in the middle of a rough patch, the bank provided an infusion of much-needed capital at a time when other banks wouldn’t consider these startups worthy of a line of credit.
Without SVB in place, or a replacement institution, startups facing a temporary setback may collapse altogether — with no credit line or loan available to save them. That gives startups the chance to respond in one of three ways. They can fold and fade out, bootstrap their way forward, or they can pivot to stronger profitability targets and more conservative spending.
In the coming months and years, expect secondary transactions and funding from non-bank sources to be the new target for companies unable to secure VC. As more early-stage startups pivot to bootstrapping as a slow-but-steady way to grow, the reliance on bank-backed funding may decrease. Especially for early- to mid-stage startups that struggle with profitability.
For the startups still set on securing bank funding, watch for these businesses to aim for higher profitability targets, slower spending, and more disciplined oversight. While small- to mid-size banks tend to offer startups more personalized service and guidance along the way, moving forward, many startups will have to work with bigger banks like Chase and Bank of America. These big banks are different from smaller relationship-based banks for one major reason: They’re subject to oversight by the Office of the Comptroller of the Currency — a regulator that monitors all big banks, and discourages loans to companies more than one year from profitability.
Not only are these bigger banks more conservative in their lending standards, preferring startups that are already profitable or nearly there, but they also may not offer the same level of mentorship SVB and small banks do. That means these startups must look to their leadership team for guidance instead of their funding sources. Instead of having access to the insights and experience of a seasoned institution, these startups will have to find their own CFO and FP&A team to guide future growth.
Over the next few years, only the strongest startups will survive
Until now, SVB and similar banks offered credit and capital with lower lending standards, and easier qualification than big banks. That meant startups that weren’t necessarily bound for success or run effectively had the chance to continue increasing their debt and struggling forward, with few checks and balances along the way. Without a clear product market fit, profitability, or stability, easy credit allowed them to survive longer than they would have if required to prove their value. And considering roughly 700,000 startups launched in 2022 alone, limiting the ability for non-profitable businesses to continue operating may be a good thing for the economy as a whole.
Startups that learn to play to their strengths — and outsource the rest — are positioned for stronger growth potential in 2023 and beyond. As capital becomes increasingly difficult to obtain, only the startups that focus their resources effectively, manage their risks carefully, and trim every bit of excess will weather this market. And those that do will come out of this recession stronger and more resilient than ever.
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