Silicon Valley Bankrupt
Customers outside a Silicon Valley Bank branch in Santa Clara, CA (Photo credit: Jim Wilson/The New York Times)
Last month I wrote one of my most-read posts on the ten biggest tech industry scandals of 2022. The early front-runner for the top of the list in 2023? Silicon Valley Bank, which failed spectacularly in the span of 48 hours last week.
The immolation of the 16th largest bank in the country has received prominent coverage in the national media, but it was earth-shattering news for those in . . . well, those in Silicon Valley. For the tech industry, the collapse of SVB, as it is universally known, is incredibly un-nerving. If you haven’t followed the bank’s implosion, here’s a thumbnail of what happened:
Wednesday, March 8—SVB seemed to be a healthy, functioning regional bank focused on the tech sector.
Thursday, March 9—SVB unsuccessfully tried to raise over $2 billion of equity to solve a downplayed near-term liquidity crunch. CEO Greg Becker urged everyone to “stay calm”—the exact words you don’t ever want to hear from a bank CEO. Shares of SVB dropped off a cliff and trading of their stock was halted.
Friday, March 10—Prominent VCs urged their portfolio companies to get everything out of SVB ASAP, triggering a text book run on the bank. Companies worried about everything from vendor payments to payroll processing, while account holders lined up outside branches like scenes from the Great Depression, except wearing AllBirds, in a desperate attempt to get their money. By the end of the day, SVB had collapsed and went into FDIC receivership—the largest bank failure in 15 years.
Sunday, March 12—The Fed stepped in and assured SVB’s depositors that they would have full access to their funds by Monday.
Today, fears of contagion are rampant after another bank, Signature, failed over the weekend. Other banks comparable to SVB have seen their share prices plunge, and broader bank stocks overall are down substantially. As the entire tech industry struggles to access their funds, pay their bills, divert their receivables, and come to grips with the biggest banking crisis since 2008, there is one question increasingly on everyone’s mind:
What the hell just happened???
As challenging as it is to cover a story that continues to unfold in real time at Internet speed, media outlets have been offering explanations from experts who often seem to have an agenda. For banking experts who want to assuage fear and stabilize markets, this was an isolated and innocent miscalculation by SVB—tying up too much of their balance sheet in long-term bonds that declined in value as interest rates rose. For proponents of more decentralized banking (read, everyone in the crypto and block chain space), this is all the Fed’s fault with self-serving jabs that “fiat is fragile” thrown around as a timely diversion from their own crisis (see FTX). For haters of Big Tech, this was pure greed caused by a handful of selfish venture capital firms who mandated their portfolio companies remove their funds from SVB, triggering an irrational, fear-based run on the bank.
In my opinion, all these are contributing factors, but they are not root causes. The explanation I’m not hearing, especially not from people in the tech industry, is that the root cause is the tech industry itself.
Let me back that up a bit. The lifeblood of the Silicon Valley tech industry is capital, specifically venture capital. Without it, no start-ups get funded, no innovation happens, no hyper growth ensues, no fabulous fortunes are made, and the whole sector looks like it did in the 1960s when it was run by big, monolithic, blue-chip companies like IBM. Founded in 1983, SVB had as much to do with the creation of the modern tech economy as any financial institution. The venture capital firms get all the glory, but there are hundreds of them and only one commercial bank, really, that served the tech industry. No other financial institution was more symbiotic with the rise of venture-backed technology start-ups than Silicon Valley Bank.
See, SVB isn’t just a regular bank. As the name suggests, they skyrocketed to become the 16th largest bank in the U.S. because of their unusually cozy relationship with the tech industry. Most venture capital firms kept their funds with SVB, and the majority of tech companies banked with SVB. I’ve founded multiple startups and worked for many more, and every single one banked with SVB. In fact, the expectation by venture investors and board members to do so was so great that we would have had to justify putting our funds into any other bank. It’s just what you did. And for over 30 years, that three-way relationship proved beneficial to all parties.
When a VC invests money in a start-up and that company banks with SVB, there’s a tacit understanding that the bank will keep an eye on those funds—even freeze or sweep accounts if needed. When start-ups need more capital, SVB provides loans other banks won’t that are collateralized with illiquid private stock (and the promise from their VC backers not to let the start-up fail), making SVB one of the largest venture debt issuers. When founders want proceeds from their private shares, SVB provides secondary market liquidity. The explosive growth of the tech industry overall drove up SVB’s stock price, reaching a market cap as high as $40 billion in 2022. In short, SVB is the central nervous system of the venture-backed tech industry, facilitating the unique banking transactions that have made so many people so fantastically wealthy.
As such, no other financial institution has deeper ties or better visibility into the state of the tech industry than Silicon Valley Bank. Apparently they didn’t like what they saw. Which brings me to my point. When banks fail, they fail because they (and their auditors, regulators, and board) grossly underestimate the risk of an over-indexed asset on their balance sheet. Washington Mutual failed because they were over-exposed in subprime mortgages. That was the root cause. SVB is failing for the same reason it succeeded: because it is over-exposed to the technology industry. That is the root cause.
Just like SVB tried to buoy confidence with reassurances that everything was fine, many in tech are doing the same thing to buoy confidence in the industry. But SVB’s collapse is a harbinger that things in the tech industry it serves are not healthy. The entire business model of venture-backed start-ups depends on liquidity either via IPO or acquisition, and both those markets have effectively locked up recently. IPO proceeds plunging 94% in 2022, while plummeting stock prices and rising interest rates caused technology acquisitions to dramatically slow at the same time. Even SPACs, the briefly hyped back door to going public, have collapsed. No liquidity = no good for the tech industry. These trends have called into question the underlying premise of venture capital as an asset class. If you can’t get your money out, why do you want to put your money in? Smaller venture funds are struggling to raise new rounds and large funds, in some cases, are quietly handing money back to their limited partners. Meanwhile, start-up companies have faced similar pressures. For unprofitable companies without liquidity options or access to public capital markets, they either need to get profitable fast (hence, the widespread tech layoffs) or raise more equity privately, usually at significantly reduced valuations.
The net effect for SVB straddling the intersection of all this is not good. Declining venture funds, down rounds at start-ups, increased cash burn by depositors, inability to service debt, and other drivers all mean the capital that flowed into SVB so torrentially in 2021 is leaving just as quickly. Compound that pre-existing condition with the shock of thousands of account holders withdrawing $42 billion in one day at the behest of their venture overseers, and you can see why the golden goose wasn’t just sacrificed but was summarily disemboweled, spatchcocked and spit-roasted. The venture firms who ran for the exits may have their money, but they may have killed the flywheel that made them their fortunes. Whatever Federally-backed or firesale-acquired entity takes over may not be as accommodating.
The dirty secret that has arguably propped up the entire venture-backed tech start-up ecosystem into ever-more-dizzying valuations has, for a long time, not been fickle public markets (who wants another dot-com bust!?), but private investors, including foreign sovereign wealth funds—a storyline that happens to be part of my novel, Bit Flip. Perhaps the most disturbing line allegedly came from an SVB insider complaining about the “absolutely idiotic" executive leadership at the bank, saying, “You’re in business for 40 years and you are telling me you can’t raise $2 billion privately? Get on a jet and fly to Kuwait like everyone else and give them control of one-third of the bank.” Like everyone else indeed.
The full fallout from this sequence of events remains to be seen, with other banks, regulators, venture firms, and tech companies all scrambling to preserve their capital. For some start-ups with limited funds, frozen accounts, and few alternatives, this may prove to be an “extinction-level event.” But the tech industry as a whole needs to clean up its act or it risks a moral, ethical, and financial bankruptcy of its own.