Silicon Valley Bank (SVB) has been making waves in the economic and financial news over the past couple of months. The once favourite bank for start-ups is now facing bankruptcy, bringing back memories of the 2008 crisis that rocked the global banking sector to its core. This sudden turn of events has caught the attention of many, as SVB's downfall could have significant implications for the technology industry and start-up ecosystem.
The collapse of Lehman Brothers in 2008 marked the beginning of a global financial crisis that had far-reaching consequences. The highly interconnected banking system meant that the crisis spread rapidly across the world, leading to the collapse of banks such as Northern Rock in the UK. Mass withdrawals by customers caused the bank to suffer from a liquidity shortage, making it unable to cope with the situation.
Fast forward to today, and the recent troubles at SVB may seem like a world away from the events of 2008. However, there is a crucial link between the two. Both crises highlight the fragility of the banking system and the potential ripple effects that can occur when even one institution fails. With Silicon Valley Bank being a favourite of start-ups and the technology industry, its potential collapse could have severe implications for these sectors, potentially leading to a domino effect that could impact the wider economy.
In this article, we strive to give an analysis of what effect will this failure have on the legal tech industry.
Classic Bank Run
Silicon Valley Bank, renowned for its specialisation in servicing start-ups and financing innovation and tech, has been hit hard in the wake of the Federal Covid policy. While the policy initially lowered credit rates to help households and businesses borrow, the end of the pandemic, along with the rise in inflation and the war in Ukraine, prompted the Fed to raise credit rates once again. As a result, start-ups turned to SVB to recover their funds and meet their obligations, leaving the bank short of liquidity. As John Wu, the CEO of the blockchain firm Ava Labs says, “This is a classic bank run”, this highlights the pressures that banks face in a rising interest-rate environment.
SVB, in a bid to survive, had to sell off some of its financial investments at a loss. Unfortunately, this move was not overlooked by tech investors, who warned their clients, resulting in a banking panic reminiscent of the 2008 financial crisis. On March 9, 2023, a bank run occurred, with customers withdrawing approximately $42 billion in under 24 hours. The bank was unable to meet this overwhelming demand, ultimately leading to its failure.
To prevent further damage, the US government stepped in and took control of the bank, aiming to reassure depositors and guarantee their funds. Jon Medved, the founder of the Israeli venture capital crowdfunding platform, OurCrowd, expressed relief following the Biden administration's announcement to guarantee all deposits above the insured limit of $250,000 per account in Silicon Valley Bank. While the situation remains uncertain, the government's intervention is a clear indication of the severity of the crisis and the potential impact on the broader tech industry, and the start-up ecosystem is yet to be fully understood.
Legal Tech Funding Declines
SVB's failure has sent shockwaves through the legal tech industry, leaving many startups scrambling to stay afloat. With their cash assets frozen and funding sources cut off, these companies are facing an uncertain future. Many of these vendors relied on the bank for funding and support, the failure of such a prominent bank could result in a tightening of credit markets, making it harder for legal tech companies to secure funding to support their operations and growth.
Compounding the issue is the fact that many of these vendors also had relationships with Signature Bank, which focused on serving the legal services and tech industries. With both banks facing significant challenges, the situation has left many tech companies struggling to meet payroll and cover their other operating costs. This could result in a slowdown of innovation and growth in the legal tech industry. Moreover, the impact of this failure goes beyond just the legal tech industry. As investors become more cautious and entrepreneurs more hesitant to take risks, the entire tech sector could feel the effects.
Several venture capital firms that invest in the legal tech market have been clients of Silicon Valley Bank, such as Insight Partners, which has invested in LawVu, Kira Systems, and Litera. According to its website, Insight Partners has invested over $600 million in the legal tech sector, which highlights the significant amount of funding that may be impacted by the failure of SVB. The failure of the bank may lead to a shortage of liquidity, which could cause concerns for venture capital firms and their investments in the legal tech space. The situation could potentially result in a decrease in funding for legal tech startups, causing them to scale back their operations and reduce their headcounts. According to Sayers, legal-tech companies may be forced to announce layoffs sooner than they had planned in the wake of the crisis.
It is worth noting that legal tech companies have already faced challenges in securing funding, even before SVB's failure. According to data from Legal Complex, legal tech funding has been declining, with many investors preferring to focus on other areas of the tech industry. Furthermore, the bank’s failure could lead to greater scrutiny of the regulatory environment for fintech and banking more broadly. With the collapse of a bank that was seen as a key player in the tech industry, regulators may be more inclined to take a closer look at the risks and challenges facing these types of institutions.
Learning From Past Crises
Although the collapse of Silicon Valley Bank poses a challenge, it is not a fatal blow to the legal tech industry. Startups may need to explore other funding options, reevaluate their business models, and operate more efficiently. The situation may also lead to partnerships or mergers with larger companies, resulting in innovative collaborations and consolidation. The industry will need to adapt to these changes, whether through alternative funding, partnerships, or perseverance. However, the lessons of the 2008 financial crisis have not been fully absorbed as we navigate these uncertain times.
Author: Varun Bhatia, Co-Founder of 3NServe.
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