SVB Collapse Sends Shockwaves Through Tech Startup Industry

For tech startups, Silicon Valley Bank wasn't just one of the banks you could work with, it was the one bank you wanted to work with. So many tech unicorns banked there, and also received loans from SVB, that banking with SVB became like the t-shirt and hoodie combo — just one of the signs that you were a real-deal tech startup.

While the bank was as American as a corn field, startups from across the world found themselves concentrated on the bank in a way that other industries might find unusual, perhaps because of a lack of compelling alternatives in their own markets and the primacy of U.S. tech in the global economy.

It should also be noted, however, that SVB became a bank of choice for the tech sector only because it was a lender to that sector with an approach that set it apart from other financing sources, and it required its borrowers to keep their accounts with the bank.

Silicon Valley Bank's demise

The Federal Reserve's vice chair for supervision, Michael Barr, set the tone for what's to come when he laid the blame for SVB's demise on poor internal management and excessive risk-taking. Barr also acknowledged in his written testimony that bank supervision and regulation might need to change in the wake of the collapse.

We'll put aside the fact that the point of ultra-low interest rates and quantitative easing, which the Fed is responsible for, was to increase risk taking and growth in the economy, and that tech is lately where much of that risk-taking happens. Ironically, I would argue that it was not really the tech sector exposure that caused the bank's demise, as many have assumed without much discussion — it was the bank's liquidity management practices.

The "excessive risk-taking" at SVB that caused its failure was in relation to it seeking marginally higher returns in a low-interest market by locking deposited funds into long-term bonds.

There was an inherent mismatch there, since those deposits were almost entirely business deposits that could move in a day to, among other things, make payroll, complete an acquisition, or pay off a credit facility. The obligation to fund those short-term transactions by selling those long-lived bonds at a discount created huge losses and ultimately, the panic run.

While the specifics of how regulators will apply any increased or new scrutiny to the sector remains to be seen, in short, the SVB model of combining banking with equity stakes and other technology consultancy services is likely over. A return to a more traditional banking model that seldom understands how startups work is more or less guaranteed.

Impact of SVB's collapse

On the ground, we're already seeing the effects. Some providers in the marketplace are offering new sweep network accounts that essentially spread a single depositor's balance across multiple banks to both take advantage of the per-bank element of Federal Deposit Insurance Corporation insurance and to generally lower bank concentration risk. But it remains to be seen how long this practice continues.

We can imagine that in the short term, bank concentration risk may be added to a few due diligence memos along with customer concentration risk and single-point-of-failure supplier risks for startups looking to make a transaction.

The reality was that everyone thought that it was a reasonable and prudent business decision to bank with SVB — until it wasn't. SVB was founded in the 1980s, which means it not only survived the global financial crisis of 2007-2009, but also the dot-com crash of the early 2000s.

It's also worth noting, while we're on this subject, that the most egregious mistake of the global policy and regulatory response to the global financial crisis was there was no mandated increase to banking competition. In fact, the sector consolidated further.

More broadly, startups are nervous on what the systemic knock-on effects might be from one or more additional failures happening. For startups, many or most really aren't mature and stable enough business models that would have redundancies for every critical vendor or functionality.

The SVB collapse made plain that even without direct exposure, and even without any actual losses of deposits occurring, there could have been plenty of disruption across the startup ecosystem from one or a few service providers to the community experiencing a disruption that cascades across all the companies that they touch.

The biggest calamity of such cascading disruption was avoided by quick action by the federal government. Although it looks like we will all pay a little toward the $20 billion price tag currently projected for that action, in the form of higher fees for banking services across the system.

First Citizens Bank, SVB's new owner, has promised to embrace the technology industry relationships SVB has created, but has little track record of its own to point to in this area.

You might say that SVB being swallowed by a more traditional bank could lead to fewer opportunities for tech sector funding overall. But I have seen a lot of interest from other alternative lenders that have developed in recent years that could step up and fill any gap that SVB might leave behind.

However, the overall rise in interest rates since early 2022 and the pullback of venture capital firms from the tech sector over the last nine months has already affected the ability of tech startups to find adequate funding from anywhere, and that condition really predated the fall of SVB.

Tech startups are likely to be facing all the same headwinds in the post-SVB crisis that they were in early March 2023. SVB was one player in two markets — banking and lending — but there are a lot of other players in both of those markets.

Eliminating the tying of banking services to lending relationships could be a good thing for system stability. Using banking service fees to subsidize lending in the tech sector, or vice versa, simply may not be worth the systemic risk that such bundling can create.

Technology companies are not like traditional companies. They work at a different pace; they're building the plane as they fly, and many appreciated having SVB as a bank and lender just because of that similar familiarity.

Tech startups that have been busy cutting costs and extending their runways will be eager to secure a banking partner that can move as quickly as they can when the economic recovery begins; who knows, maybe it will be one or more fintech startups who step up to meet those needs.

This article was first published by Law360. (Subscription required)

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