Silicon Valley Bank's collapse could turn some capital-starved venture capital firms into the walking dead, that is, unable to raise new funds.
Venture capital was already suffering reversals from the heydays of 2021 and 2022, with low returns or losses, pricier debt and fewer transactions, including exits.
But the Silicon Valley Bank debacle is expected to deal a deadly blow to some venture capital firms due to a lack of liquidity.
When interest rates were low and there was ample financing, venture capital firms "could take on more risk and more leverage, which in turn created a lifeline for zombie funds that were able to continue to exist as a result of access to cheap credit," said Mina Pacheco Nazemi, Charlotte-based head of Barings LLC's diversified alternative equity business, which creates customized private equity and real assets solutions across co-investments, secondaries and primary funds.
"However, bankruptcy could now be looming for startups that are unable to obtain additional sources of financing and as increasing costs compress profits. And there could theoretically be an increase in zombie venture capital firms that can't raise new funds," Ms. Nazemi said.
Already posting poor returns, VC firms could linger in the venture capital ecosystem for years, surviving off the management fees of their existing funds, industry insiders said.
Typical performance fees are 20% and management fees usually are 2% on aggregate commitments during the investment period, with larger funds generally charging higher fees regardless of how the funds perform, according to PitchBook Data Inc.
Venture capital returns haven't been pretty: venture capital delivered a -14.9% internal rate of return year to date as of Sept. 30, lower than the -6% buyout return in the same period, according to McKinsey & Co.'s Global Private Markets Review 2023 released March 21.
This was the first time venture capital posted negative returns and underperformed buyouts since 2017. And returns for existing funds are poised to keep falling, although consultants say 2023 vintage funds could be top performers due to lower portfolio company valuations, a tough macro environment and fewer exits hampered by the closing of the initial public offering window.
"There will be venture capital firms that move to a zombie state," said Maelle Gavet, New York-based CEO of accelerator program operator and venture capital firm Techstars Central LLC, with $1 billion in assets under management.
Emerging managers will have the toughest time, she said.
"Because valuations are going down it will be hard for emerging managers to prove themselves," Ms. Gavet said.
And with investors affected by the denominator effect — that is, their public portfolio loses value, boosting the value of the private capital portfolios above target allocations — they will focus on the venture capital firms proven to be safer and more stable, making it much harder for emerging managers, Ms. Gavet said.
"What is happening for Silicon Valley Bank is a real shock to the system," she said.