The credit crisis is in full swing through most of the U.S. economy, but it has barely touched venture-fueled Silicon Valley. Until recently, that is. Up to 20% of venture backed startups may have been convinced by their financial advisors to put much of their spare cash into something called Auction Rate Securities, on the promise of money market-like liquidity with better returns. Now, that money is frozen, and startups are scrambling to find a way to free up the cash.
Auction Rate Securities, a $330 billion market, are rolled over periodically (every 7, 28 or 35 days) to allow quick liquidity for investors. In their 20 year existence the markets have never stalled. Until February, that is, when concerns over the health of the municipal bond market froze these auctions. Since then, anyone holding the securities has been unable to get any liquidity, and the end of the freeze is nowhere in sight. Venture capitalist and blogger Paul Kedrosky has been talking about the issue regularly on CNBC.
Some big companies have been hit. Jet Blue, for example, had $611 million, or a 72% of its cash and investment securities, tied up in ARSs. But in an informal survey, twelve out of sixty venture backed startups had some amount of cash in these securities, too. Often without the knowledge of the venture capitalists who financed them. A venture capitalist says that he believes 5-10% of total invested cash is frozen.
Those VCs are now scrambling to help their portfolio companies find alternate sources of cash to meet payroll and other obligations. The first call is often to Silicon Valley Bank, said one venture capitalist who has a number of portfolio companies in “deep cash flow trouble.” Another said that brokers are loaning money back to the companies at about the same rate that the frozen securities are paying, giving them some liquidity.
Comerica has been mentioned in many of the calls I’ve had venture capitalists, who say that the bank advised their clients to invest in ARSs as safe alternatives to money market funds, with a higher rate of return. “We just had no idea this was even a risk at all,” said another VC.
Update: One startup that specializes in illiquid securities, Restricted Stock Partners, is trading ARSs on its electronic market. So that might be an option for some cash-strapped startups.
Update 2: A February 21 note from Silicon Valley Bank enumerates the carnage: “Auction Rate Securities of all forms are failing at a daily rate between 70 to 80 percent or between $15 to 25 billion.” Gulp.