After the Silicon Valley Bank crisis, technology supplier risks raise the bar for due diligence

The technology startup ecosystem remains in a state of uncertainty as federal authorities review bids for Silicon Valley Bank and a bridge bank handles daily operations.

The venture capital pipeline that once flowed through Silicon Valley Bank to young companies, supporting their growth, had already been under pressure due to inflation and rising interest rates. Although the downstream impact on funding and innovation is unclear, the potential consequences are severe enough to prompt companies to re-examine their vendor portfolios.

Brad Haller, senior partner in the mergers and acquisitions practice at technology consulting firm West Monroe, said in an email that the short-term disruption has introduced a sense of caution into the tech startup ecosystem that will persist until the market regains confidence in cash flows.

"This delays innovation in the technology economy overall," Haller said.

For technology leaders whose vendors bank with Silicon Valley Bank, immediate concerns about vendor viability were eased when federal authorities stepped in and guaranteed existing deposits after a bank run forced the bank into receivership. But tech startups themselves are volatile, and uncertainty about their stability remains.

Ronak Doshi, technology business partner at IT consulting and research firm Everest Group, noted that Silicon Valley Bank's support role extended beyond banking to "social events, summits, and product, risk, and financial advisory services."

The institution also expanded the pool of available capital. Venture debt, a specialized type of loan designed for early-stage, high-growth startups that lack positive cash flow but have secured funding, was one of Silicon Valley Bank's core businesses.

"They were a key provider of venture debt," said Scott Bickley, business lead and principal research director for vendor management and contract review at Info-Tech Research Group. "They provided loans based on the size of a startup's venture capital funding, enabling these companies to access additional financing beyond their core equity."

The collapse of Silicon Valley Bank also disrupted credit lines critical to business operations. Thomas Phelps, CIO and senior vice president of corporate strategy at Laserfiche, a Long Beach, California-based enterprise software company, told CIO Dive this could create short-term problems for some startups.

According to Phelps, Laserfiche has contracts with more than 100 software and IT service vendors, but only about a dozen of them bank with Silicon Valley Bank. Although these vendors remain safe for now, some risk persists in the broader ecosystem.

"IT leaders should realize they have some buffer time right now," Phelps said. "But what happens if these tech startups lose access to these credit lines in the future?"

Long-term concerns

The disruption in Silicon Valley could ripple through the middle tier of enterprise IT portfolios via third-party vendors that depend on the supply chain. "I worry that three months from now, some of their critical components could be compromised," said Wendy Pfeiffer, CIO of Nutanix, a San Jose-based cloud software company, during a March Wall Street Journal CIO Network panel discussion.

Startups that survive the initial crisis may face additional risks due to higher capital costs and more cautious lenders.

"High-quality companies will get through it, but a lot of innovation could be affected," said Vineet Jain, CEO and co-founder of Egnyte, a Silicon Valley software company, during the panel discussion.

Forrester noted that vendor risk has always been a concern for enterprises, but third-party risk should now become a more prominent issue. In a recent blog post, the research firm said that while innovation from startups should continue to be embraced, rigorous vetting processes should become the norm.

Forrester recommends that IT leaders continue testing promising products while mitigating risk by reviewing vendors' financial health and identifying backup vendors with comparable offerings.

"Supply chains and hidden dependencies are things I always worry about," Jason Conyard, CIO and senior vice president of VMware, a Palo Alto, California-based cloud computing company, told CIO Dive. "Business continuity planning isn't just about earthquakes and hurricanes; it also includes supply chain challenges, geopolitical situations, and economic uncertainty."

Heightened scrutiny

Vendor vetting is a critical part of building stability, resilience, and security in enterprise IT.

"When you bring a new vendor into your technology ecosystem, you have to assess security and data privacy impacts, as well as the risks posed by third-party vendors providing services and technology," said Phelps of Laserfiche.

If a vendor is publicly traded, Phelps reviews its financial reports; for private companies, the process is more complex.

"I want to know how long they've been operating, who the founders are, what funding round they're in, and how much cash they have on hand," Phelps said.

Understanding who vendors work with is also important, not just in terms of banking relationships, but also the technologies and services that could disrupt the supply chain.

"Many vendors, even tech startups, rely on other companies' services to provide services to you, so things can get very complex very quickly," Phelps said.

As the Silicon Valley Bank situation settles, Forrester expects M&A activity in Silicon Valley could increase, as companies prepare to opportunistically acquire struggling startups. This could also introduce risks, altering the relationship between vendors and their customers.

"Vendors could shut down quickly," Phelps said. "As part of our process, we look at contract terms with these vendors: what happens if the vendor is acquired by a competitor, and how we access our data when exiting an agreement."

For startups, self-examination may also be necessary, especially when it comes to banking relationships.

"The most important thing on everyone's mind is cash management and diversification," AJ Bruno, co-founder and CEO of software startup QuotaPath and a former Silicon Valley Bank customer, told CIO Dive. "Now, ensuring we take a multi-threaded approach is our fiduciary responsibility, which was never really exercised in the past."

Asking startups which bank they use and whether they have M&A or IPO plans has now become a priority.

"We've asked similar questions in the past, but now we ask more and deeper questions," Phelps said. "And these questions come at the beginning of conversations, not the end."