The Dot-Domino Effect

Behind every dot-com failure lies a host of unhappy creditors. Here's how the happy few have managed to mitigate the risk.

Several major banks, including Bank of America, have announced major bad-debt write-offs in recent months. SVB itself was recently downgraded by two of its analysts. The cause: a drop-off in deposits and a drop in the value of the warrants it holds in more than 1,000 companies, which are a mix of technology- related businesses. Ironically, bad-debt write-offs have not been one of the bank’s problems, says CFO Chris Lutes, primarily because SVB does business only with dot-com companies that have some sort of intellectual property, whether it’s proprietary software or patentable processes.

“A traditional bank will look only at a company’s cash flows,” says Lutes. “But for dot-coms, there often aren’t any. If there’s underlying intellectual property, and a company goes under, the venture capital backers will look to quickly merge or sell the company’s assets. If there’s no intellectual property, there’s nothing for them to sell.” This means that SVB’s loan exposure is mostly to early-stage Internet- related technology and software start-ups, not business-to-business or business-to-consumer dot-coms.


When evaluating a company’s creditworthiness, Lutes says, SVB also looks at the company’s other assets, such as accounts receivable (backing out foreign receivables and past-dues). In addition, it closely examines the amount and source of a company’s venture capital funding, and lends only a portion of that. Lutes says that SVB is more likely to lend to companies that are funded by firms with which the bank has a prior relationship. And, he adds, “We always look to make sure that the venture capitalists have some skin in the game.”

SVB also generally sets a $500,000 limit on loans it makes to Internet-related companies. As a result, SVB’s total loans outstanding to these companies are just $30 million on a $1.6 billion loan portfolio. As a bank, SVB has a unique risk advantage over other businesses, because the loans it makes are secured, and it is the first in line during bankruptcy proceedings.


Experts stress that before extending credit to a dot-com company, it is important to understand the structure of its funding. Many start-ups receive their venture capital in stages after they hit certain performance milestones. “Often at the first glance at a company’s balance sheet, it looks like it is going to run out of money in two months,” says Benjamin Wilner, senior economist with LECG LLC, an economic and financial consulting firm in Evanston, Illinois. “But there could be another milestone it’s going to hit in a month and a half. You need to know what those milestones are and if the company is going to hit them.”

But most important, say experts, is to hold to the fundamental methods of evaluating a company’s potential. “Do not get caught up in metrics like market share and eyeballs,” says Wilner. “You need to use your business acumen to come up with a model to determine whether or not you think the business model makes sense, and whether or not you trust that the people running the company have the ability to implement the model.”

If your company is already overexposed to dot-com risk, Moody’s Konefal suggests taking the most conservative position possible when recognizing revenue from those customers.

“Don’t book that revenue at full value,” he advises, “and create a meaningful bad- debt reserve. From where we sit, diversification of customer base is what we like to see.”

Kris Frieswick is a staff writer at CFO.


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