Silicon Valley Bank focused on the startup sector, and that’s part of the story of why it failed. Lack of diversification means more risk. But SVB’s focus has real benefits as well: It allowed the bank to build up a tremendous amount of tacit knowledge about how startups and venture capital worked. The best result would be for a big bank to buy SVB whole, so that that knowledge doesn’t get lost.
In the wake of the Silicon Valley Bank (SVB) collapse, commentators have rightly highlighted the additional risk that the bank bore by being so heavily concentrated in one sector: venture capital and startups. Less discussed are the benefits that such concentration provided. As regulators, VCs, and potential SVB buyers take stock of the collapse, it’s important that both sides of that coin get considered.
Clearly, SVB’s focus on a single sector increased risk and is a major factor in its collapse. Its problems started with the large increase in deposits caused by a surge in startup funding. And the hyperconnected nature of SVB’s clients meant that a run on the bank could happen virtually instantaneously. If SVB had been more diversified on the deposit and lending side or if SVB had been one small piece of a large financial institution, the risk of a bank run would have been greatly diminished. One of the basic principles of finance is that diversification reduces idiosyncratic risk.
But that’s not the end of the story. It’s also worth recognizing the tremendous benefits to specialization that allowed SVB to become such a force for startups. Having personally known SVB and much of its senior management for more than 30 years, I am intimately aware of what the focus on venture capital and tech startups has meant for the industry. SVB focused and understood the need of the startup community, offering products and services that were tailored to its needs. From venture debt lending to cash management for startups and VCs to wealth management for newly wealthy entrepreneurs, SVB focused on understanding the entire lifecycle of capital within the startup ecosystem and designed a business to address the myriad needs of the community.
And this model proved valuable well beyond the geographic confines of Silicon Valley. SVB had a major presence in the tech communities of Israel and Europe, because it truly understood the needs of the startup industry. Through its fund of funds, the bank was a major investor in many of the leading venture capital firms, providing SVB with important insights into underlying trends in investing. The information gleaned through these limited-partner stakes was helpful in being able to work with and provide credit and other services to startups. This was a big benefit to the startup ecosystem.
Similarly, SVB’s deep relationships with both VCs and companies could be a source of important networking opportunities for entrepreneurs and investors alike. The products and services that SVB could offer evolved over time to meet the needs of the rapidly changing technology landscape. SVB was a critical piece of the ecosystem and was incredibly important for helping the industry mature and grow. Because it had personal insight into companies and founders through its extensive network, it could operate quickly and efficiently.
The most likely outcome of the SVB collapse seems, as of this writing, to be a sale of various pieces of the bank to multiple buyers. If that happens, startups will suffer. Debt financing, which many startups utilized to fund development of cleantech, life science, and other deep technology, will be harder to get and become more expensive. This will slow the pace of tech development and likely lead to more firms closing. Cash management will become more complex as firms that raise large amounts of capital now spread that cash to many different banks. The role of the startup CFO will be ever more important (and more complicated). VCs are likely to pay more attention to the cash balances of startups and may focus on smaller, tranched rounds of investment that lead to more complexity and hurdles for the startups. Valuations and the pace of investment are likely to be affected as well. 2022 was a reset year in the startup and tech world. The collapse of SVB will only make it harder for normal funding to resume.
What should the startup world expect going forward? Can we have the best of both worlds? Some of that depends upon what happens with the SVB business. There will certainly be banks that step in to do the various pieces of what SVB did. There are private debt providers circling to bid on the loan portfolio. Other financial firms are looking to buy pieces of the SVB, like wealth management. Many of the large banks have long desired to have a larger presence in the startup world. Servicing startups can lead to lucrative IPO underwriting and other services. So, yes, the VC and startup sector will have places to go.
But having so many tentacles in the industry allowed SVB to build decades of embedded knowledge on the people, the issues, and evolving needs of the industry. That won’t be fully replicated by other banks. Unless someone were to purchase SVB in its entirety, I don’t think any one bank will take the role in the ecosystem that SVB did. While the products and services can be replicated in larger financial institutions, much of SVB’s tacit knowledge was embedded in the people and networks it had formed. Those will be virtually impossible to replicate in pieces.
SVB’s failure raises difficult questions about the role of midsize, specialized banks. They present unique risks that need to be mitigated. But as SVB illustrates, they also provide important benefits. In this case, the least disruptive solution and the one that would keep most of the benefits of SVB’s specialization in place would be to sell the bank in its entirety and to have the bank continue offering the kinds of services it historically provided, albeit with a much less risky balance sheet. If someone at the FDIC is listening, I believe that is the best option for preserving value.
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