Question Time for startups and venture-capital firms who banked with Silicon Valley Bank: it’s Monday and the feds say you can withdraw your deposits in full. What do you do with the money?
Silicon Valley Bank, an institution critical to venture capital and startups, was wiped out in a panic on Friday, March 10. On Sunday night in the US, federal authorities announced depositors would be made whole, so they can make payroll and continue to operate.
Saving depositors is good. The Federal Reserve did it to stop panics from affecting other US banks. In the case of SVB, it is also good because SVB’s customers are the primary incubators of innovation, both in the US and in Asia and Europe.
The startup and venture industry now has a different problem, because there is no substitute for SVB. Yes, there are other banks. But none like SVB, which evolved into a critical part of the financial landscape for global innovation.
Venture banking
The bank was founded in 1983 in San Jose, California to provide venture debt. Startups are too risky and unknown for a regular commercial bank to accept them as a customer. This is why startups depend on venture capitalists providing equity.
The other challenge to banking startups is that they don’t borrow much. A bank makes money by accepting deposits and using those to lend. This is the case with blue-chip corporations, which are reliable borrowers, but not with startups.
SVB got its start by inserting itself into VC deal flow. It captured most of the market because it was willing to lend to both VCs and their portfolio companies. SVB protected itself – and wielded influence – by becoming critical to a VC’s entire suite of companies. If a startup looked like it would go under, the VC made darn sure that SVB was first in line to get repaid, lest it risk tainting its reputation – and that of all its other companies – with the bank.
SVB in turn made money by banking deposits, on which it could earn interest. It did make loans, such as bridge financings to startups that needed some expansion capital. It also became the personal bank of choice to entrepreneurs, providing them with mortgages and wealth management. It invested in Napa wineries, which turned into a business expense, used to host industry events.
SVB also became the bank of choice for overseas VCs and startups that were positioning for an eventual IPO in New York. Its list of custody clients also includes many top names in Asian private equity. For foreign companies, no other US bank was so enthusiastic about opening a deposit account for them.
SVB’s international role
By the early 2000s, the Asian tech scene, particularly in China, was taking off. But Asia lacked a viable venture-capital industry. The biggest firms in the US, such as Sequoia, Kleiner Perkins, and Accel, had no interest in Asia, or anything beyond an easy drive from their offices along Sand Hill Road.
SVB, though, had a different perspective and could see the growing interest from Asia. It first attempted a tie-up with Aozora Bank, owned by SoftBank, but this didn’t work out. SVB was undeterred, although it realized that Japan, for all its technical prowess, was not the right destination for venture capital.
In 2004, SVB initiated trips to China and India. It booked flights for the most influential venture capitalists in the US to visit these emerging markets, and made introductions with local fledgling VCs and important startups. These connections led to the establishment of leading partnerships, including Sequoia and Kleiner Perkins in China, and Accel in India.
SVB went on to set up a local bank JV in Shanghai with Shanghai Pudong Development Bank, although most of its activities in Asia were incubating and managing a proprietary startup portfolio. But its greatest value was to provide a pathway for Asian tech companies to obtain a US bank account and tap SVB’s network of US lawyers, investment bankers and accountants to secure an IPO.
Concentration risk
The loss of SVB therefore leaves a gap that cannot be filled by simply moving deposits to another US lender.
For startups this will be very painful. The unique business model of SVB required concentration. Of the bank’s $173 billion of customer deposits at the end of 2022, most were uninsured – $152 billion were uninsured and only $4.8 billion, or 2.7 percent of deposits, were fully insured (that is, covered by the $250,000 limit set by the Federal Deposit Insurance Corporation; these smaller accounts probably represent individuals’ personal deposits, while the rest are corporate accounts).
For VCs, this is a startling concentration risk, but SVB’s networking power was valued; there was otherwise special about banking there, as SVB didn’t offer a premium on the interest it paid depositors.
Also, Silicon Valley is still a parochial place, and SVB was like a local community bank, an essential part of the fabric.
Finally, for startups, the assurance that they didn’t need to go through the pain of spreading their deposits among multiple banks or money-market brokers was a relief – particularly for companies from China, which might struggle to find providers in the US.
The problem was the balance sheet: SVB wasn’t acting like a bank with all these deposits, because startups and VCs aren’t major borrowers. Instead, it put the majority of its assets into bonds. The result was that placing overnight deposit money in a SVB account was more like investing into a bond fund than placing it with a traditional bank.
Losing balance
The 2020-2021 boom in all things digital, fueled by Covid and massive government spending, led to an inrush of deposits, but there was no commensurate changes to the bank’s investments on the asset side of its balance sheet.
Most of the new deposits went to medium-duration bonds: the bank’s hold-to-maturity assets expanded seven times in this period, from $13 billion to over $90 billion. Some deposits also went to short-duration bonds, with an average yield of only 1.79 percent. Once interest rates began to rise, these short-term instruments had to be marked to market, and they showed an impairment of $1.8 billion were they to be sold.
The bank could have ridden this out, but rising interest rates also led many startups to weaken, as their VCs turned off the equity spiggots. Startups began pulling deposits to pay salaries and rent. The interest-rate hikes that began in late 2021 hurt SVB’s liability side (deposits) as well as its asset side (short-term bonds).
As the Fed was beginning to raise interest rates, SVB’s management appears to have been in turmoil. Its longstanding chief risk officer, Laura Izurieto, left in April 2022 and no replacement was made until January 2023. As interest rates continued to undermine the value of SVB’s assets, the company had no one in charge of managing its risks. Meanwhile, filings at the Securities and Exchange Commission show many SVB top executives have scrambled to cash in options or sell shares over the past year.
Botched response
This led to a botched effort to protect the bank’s finances. The bank decided to sell some of its liquid securities (those marked “available for sale”) and accept the loss, in order to pivot into short-duration bonds with a higher yield. Along with this, the bank initiated a $2.25 billion capital raise, with credible investors such as General Atlantic participating.
But this news was badly communicated, and the tightly knit VC community panicked. SVB’s announcement of the raise didn’t explain why it was doing this. It informed regulators and bank analysts but didn’t communicate with its customers. By the time SVB got around to doing so, Silvergate Bank, a US bank focused on banking crypto-industry companies, was collapsing. By the time SVB CEO Greg Becker implored VCs and startups to “stay calm”, it was too late. Peter Thiel’s Founder Fund was among those recommending its startups pull their money out. On Friday, customers withdrew $42 billion of deposits.
Startups were caught in a bind. They knew that abandoning the bank was likely to kill it. But they didn’t dare risk losing their money. The Federal Reserve, US Treasury and FDIC jointly announced on Sunday they would ensure all deposits are paid in full, but this is too late to save the bank, which went into receivership.
No substitute
Had those deposits not been guaranteed, the damage to startups and the US innovation economy would have been massive. SVB banked 40,000 tech companies, representing the cream of US and global entrepreneurs. Many would have been wiped out.
These companies can now live to fight on. But they will need banks. Some may struggle to get a new one, particularly those companies based overseas. In this environment of rising rates, the big commercial banks like J.P. Morgan, Citi and Bank of America may not be keen to aggressively bank VCs and startups without an obvious channel for their own lending. Nor are they going to help startups network with important people on Wall Street.
Moreover, the risks of venture lending haven’t changed. Commercial banks are not good at assessing startup risks. SVB managed that risk via concentration, making sure it was too big to screw over. In turn it provided convenience and services to startups, founders, and VCs that they may not find elsewhere.
The result is likely to be a move away from concentration. VCs will counsel their portfolio companies to open multiple bank accounts. That means costs and time for startups. But these new banks won’t have a network to help startups go IPO or do an M&A deal. The concentration that ultimately made SVB fail was intrinsic to its value proposition. As the techies like to say, it was a feature, not a bug.
