It’s been only 15 years since the financial crisis of 2008-9, after which governments and regulators scrambled to compile a plethora of legislation and regulations, designed to ensure banks could never collapse again.
But if the industry’s collective memory usually protects it from repeating the same mistakes for a generation, it seems to have fallen short this time. Indeed, the recent failure of Silicon Valley Bank (SVB) has been heralded as the second largest bank failure in US history. SVB was America’s 16th largest bank, with over $200bn in assets. SVB was also the leading banker to the wine industry in California’s Napa and Sonoma counties.
This was followed by the closure of high net worth and crypto friendly Signature Bank just two days later. And Signature itself followed the more orderly winding down of cryptocurrency specialist, Silvergate Bank, shortly after the collapse of the FTX cryptocurrency exchange.
It is curious that a bank collapse could rock the venture world so much. Traditionally, earlier stage businesses do not use bank loans. This changed, partly due to SVB’s promotion of ‘venture debt’ – high interest loans with light terms that were offered to select VC backed, or ‘sponsored’, portfolio companies. VCs encouraged the use of these bank loans, as they supplemented the equity that they provided whilst diluting their equity stakes less. The loans also formed useful bridge finance between fundraising rounds or before IPOs.
As the crisis unfolded, fear escalated due to the sheer scale and nature of deposits – much of Silicon Valley’s funding and entrepreneurial capital were tied up. Many of the deposits were built up during the pandemic tech boom. If these funds were lost, there could be a significant hit to the global innovation flywheel, radiating from the Bay area nexus outwards.
So, how did SVB collapse, and what can entrepreneurs and venture firms do to protect themselves against shocks of this kind?
How could it happen?
At the core of SVB’s collapse was classic poor, or lack of, risk management. A mismatch of the duration of assets and liabilities. SVB, which had not had a head of risk management at its California HQ for 9 months, had invested deposits heavily into hitherto ‘safe’ US government bonds. These bonds had been treated as ‘cash’ as they could be sold.
The problem was that when selling these bonds at current market prices, to enable deposits to be taken out by customers, their value had reduced too much, as a result of the US central bank, The Federal Reserve, increasing interest rates aggressively. SVB’s deposit book had also ballooned over the last few years and it had not created appropriate policies for this new reality. Further, SVB has not foreseen that interest rates would rise so much, nor it seems, hedged for that eventuality.
Why SVB’s management and Board, and the supervisory San Francisco Federal Reserve’s office did not spot this crack in SVB’s balance sheet will no doubt be a rolling story. Interest rates were raised by the US Federal Reserve to counter US inflation. Ironically, it was that macro-economic environment that had led venture backed entrepreneurs initially gradually, and latterly rapidly, to run their deposits down to cover increased costs, and counter a tougher fund-raising environment. Plus, they could get competitive deposit interest elsewhere.
The ensuing deposit ‘run’ of $42bn in days was accelerated by the leading Silicon Valley VCs like Founders Fund and Coatue warning their portfolio companies to remove their monies. Then further accelerated by tech savvy entrepreneurs panicking on Silicon Valley’s own social media channels!
Gregory Stoller, a Senior Lecturer at the Boston University Questrom School of Business, is not surprised. “It used to be that companies reacted to a 24-hour news cycle strategically. Unfortunately, this has now become a 24 second news cycle. So, people are making decisions in the here and now without necessarily considering all aspects of a ‘what if’ type scenario.”
The US Federal Reserve, the UK’s Bank of England and other national regulators have been quick to react, swooping in with urgent measures to protect SVB depositors. But, in different ways. The US has taken the unusual decision to nullify depositors’ losses by covering them in full. This is counter to the previously established FDIC guarantee of $250,000 per deposit per depositor. They have argued that this will stem the contagion.
Peer banks’ stock prices tanked on global stock exchanges, led by the NYSE. Partly due to concerns that the FDIC wouldn’t repeat this move if other banks failed. Credit Suisse has been bailed out by the Swiss government, and, unusually, US bank First Republic banked $30bn from 11 larger US banks to prop it up. It took nearly a year for the tremors from Bear Stearns’ fall to impact Lehman Brothers, and then create the Global Financial Crisis 15 years back.
The UK approach to SVB’s failure was to sell the UK loan book and deposits to HSBC for £1, with a £2bn injection of cover. The UK FSCS, equivalent to FDIC, has not had to pick up the pieces – and the UK £85,000 per depositor guarantee was not tested. This means that the roughly 3,000 SVB UK clients can continue to manage their accounts and loans.
The measures taken by UK and US authorities have enabled VCs and entrepreneurs to protect 100% of their deposits, pay bills, and continue business as usual, avoiding a Silicon Valley financial meltdown. SVB shareholders meanwhile (amongst them pension funds) have had their investments wiped out.
While calamity may have been averted for now, bail outs of this kind can create ‘moral hazard’ – almost tempting banks to take on risk, fail and feel backstopped. The SVB and Signature Bank failures will add to all US bank customers’ fees to the FDIC. If this gets worse, it will cost taxpayers directly, like in 2008. It remains unclear how SVB’s current loan book will be managed.
There are multiple ripples washing over the venture community. SVB’s collapse will affect business, and investors’ confidence, even if they escaped relatively unscathed at face value – at least in the UK and US. SVB had tentacles as far afield as Israel, Latin America, India and China. One Australian entrepreneur even crossed the Pacific just to get his company’s cash out of SVB! That global network has now been severed. It is hard to know how such cross-border venture banking connectivity will resume.
Furthermore, account holders may not get the same ‘love’ from larger banks that do not understand their business models and will not advance such easily accessible loans. The price of loans is likely to go up as banks’ own funding costs and defaults rise. Venture or private equity firms will find it harder to use leverage, including for larger transactions, such as for buyouts, family succession sales, etc. This will have a knock-on effect, impacting M&A and IPO pipelines.
What should businesses do to protect themselves?
1. Diversify banking relationships
One of the first steps all businesses should take – often decided by your Board’s policy – is to diversify bank operating and deposit accounts. So, if governments return to the limited guarantee limits (e.g. $250,000 per depositor per bank institution in the US), there is less ‘concentration risk’. You benefit from both better cover for your hard-earned deposits, and business continuity can be maintained. Having multiple accounts can also help you take advantages of the government guarantees offered, which are usually available per institution. Finally, it’s worth remembering that long term deposits, versus ready access accounts, can tie up your cash in scenarios like these – so can pose additional risks.
2. Consider non-bank alternatives
Use independent payment gateways, that themselves have multiple bank relationships. Try non- bank providers for foreign exchange. Or, for cashflow positive businesses, try receivables or trade finance to bring in cash faster. But, be aware that some are not regulated.
3. Never assume your bank is ‘too big to fail’
Another key learning from recent days is that businesses need to keep regular tabs on the institutions they bank with. As soon as you see any nervousness in the market, you can quickly transfer your deposits to one of your alternative accounts. Even European, heavyweight banks like Credit Suisse have ‘materially’ deteriorated over the last year. Credit agencies, like Moody’s have only just reduced their ‘ratings’ for the bank sector post SVB but did not foresee recent events – just like they didn’t predict the events of 2008!
Small banks can be more vulnerable. Yet, larger banks have historically been more bureaucratic, for example, taking longer to process ‘Know Your Customer’ (KYC) checks on new, or even existing customers. Neo/app-based banks can be easier to use but have no branch networks. So, you can’t even stand in a line outside, trying to withdraw your deposits. Larger banks tend to be slower adopters of new technologies and don’t always foster the fintech ecosystem.
4. Choose banks that ‘get’ you
Although it could at first sound counter-intuitive, it’s worth considering working with smaller, or regional banks. They often offer better deposit rates and a more personal, tailored service. Though, these banks may find it harder to offer loans, due to market pressures following SVB’s collapse, specialists, like PacWest Bank in the US, offer great, free or discounted ‘perks’ programs. These can include free server credits on AWS, insurance and payroll software deals; and subscription benefits, such as for complimentary Qodeo membership. Banks like Regions in the US or Metro in the UK may have a better footprint where you are located, or longer branch opening hours.
5. Check the insurance status of your banking solutions
Many banks offer cash management solutions that provide insurance above the standard limit, so look into what is covered by your current solution and consider alternatives if you are exposed. Investor backed companies have a fiduciary duty to their stock/shareholders to look after their cash, as well as maximize returns.
6. Refinance & corporate venture risks
A number of SVB clients were using ‘bridge loans’ between funding rounds, acquisition or IPO. They may now be facing problems getting these refinanced. Future availability of such facilities may be limited. It is also possible that, as in previous down cycles, corporate venturers could withdraw or reduce their investment in growth businesses. This may affect fintech or other innovation. SVB itself had a venture investing wing, SVB Capital, which has survived its sister’s insolvency, but it will not be as active as before.
7. Raise more equity, rely less on debt
Seek to raise more venture type equity. Venture debt (loans) is likely to be harder to get, or more expensive. As a leading VC said at a recent Boston University-Qodeo event, entrepreneurs need to raise more to cover costs in an inflationary economy.
Qodeo is here to help.
We recognize that the cashflow of entrepreneurs who banked with SVB may be impeded, and some of their suppliers could also get caught up in the cross wires. You may also need to raise more equity to fill funding gaps and build a capital buffer. It can be better to over-raise, so you can ride out your cash burn cycle, while the economy is trickier to navigate. All these stresses distract you from running your business.
Qodeo can help you identify and rank best fit potential funders, in minutes. Qodeo is designed to help you to focus on growing your business, rather than being distracted by the admin and research part of the funding process.
To support affected businesses needing to fund raise at this difficult time, we are offering 3 months’ FREE subscription to Qodeo. Simply use the code SVB when you sign up for a Qodeo Pro or Concierge account.