😱 SVB and the tangled web
Why the collapse of SVB might really matter... and how it might all work out in the end
It’s 945pm on Saturday night and I’ve spent the day mulling the collapse of SVB, the banker to the tech industry in Silicon Valley and, to a large extent, in the UK. After mulling and reading and thinking, I do think what is happening could be really problematic.
I first came across SVB in 1996 at a dinner in San Francisco. So I’ve known them for a while. I even banked with them a decade ago. They were a unique bank then - able to support the peculiar needs of early-stage startups (big ambition, big vision, varying amounts of cash, weird balance sheets and funny revenues) where traditional banks couldn’t. But they were basically bankers: holding deposits, making payments and then, increasingly, providing non-dilutive venture debt. It was a specialist catering to a then-small sector that could not be understood by the HSBCs of this world. (God we tried.) I've not dealt with SVB since 2014.
The collapse of the US and UK banks means that hundreds of billions of dollars of cash held by thousands of startups are at risk. For many of these firms, it’ll mean a liquidity crisis like no other. Unable to access their cash, they’ll fail to make payroll, pay creditors and ultimately go to the wall.1
But in a free market, what is the problem with that? After all, if these startups have real prospects, they’ll be able to reconstitute and raise money from Mr Market once more. Their existing equity will go to zero but thems the breaks. In Britain, firms could do a pre-pack and be up and running with new equity holders in a matter of days.
But forget about the existing shareholders of said startups. Let’em squirm. Thing is, these startups are often highly specialist firms building on really difficult technologies with long payback periods. Carbon nanotubes, quantum sensors, carbon capture, protein engineering, anyone? It isn’t all direct-to-consumer subscription plays or five-minute delivery. You can’t just walk into the street and find capital for a hard-tech firm. In this case, the market’s allocation processes are a bit skewif.
Of course, it’s not quite the all-or-nothing scenario. In the US, the bank insolvency processes mean that firms who bank with SVB will be able to secure $250k per account on Monday morning via the FDIC. More might be forthcoming later in the week. In the UK, the first £85k is paid out per account. The funny thing is that for many young startups, $250k will meet one month’s payroll. And if your burn rate is well above $250k a month (excluding founder salaries which should be zero or lower during times of firm turmoil), you should have a part-time CFO who will already have taken steps to ensure you don’t have single bank liquidity risk. And if you are burning $250k a month without having paused to put those systems in place… well when you move that fast you break some things.2
The ugly contagion risk
There is an obvious risk of contagion in the banking sector. Watching one large (but not systemically important bank) go under, might trigger other bank runs. Might. But let’s say it doesn’t. There are still other dangers looming. Imagine, SVB’s failure in the US and UK is allowed to play out with minimal intervention. The damage wouldn’t be isolated nor would it be short-lived.
The venture contagion risk. Venture capitalists might not be the easiest group to sympathise with: what with the fleeces, five am ice baths and huge management fees.3
But they actually perform a useful function in our economies. I mean it wasn’t Wells Fargo that incubated Moderna. It was a VC firm, Flagship Pioneering.
Startups have many investors so it’s quite likely that virtually every VC firm has large numbers of portfolio companies facing the SVB liquidity wall. If those portfolio firms fail, the VC firms will face writedowns. The weak will die (never mind) but the survivors will find their strategies blunted and face years of reconstruction.
The underlying allocators who fund VC firms are an unemotional bunch at best. They are stewards of pension funds, retirement programmes and sovereign wealth. Their decisions are made by rows on a spreadsheet, not the cadence of verse. VC firms which underperform today because their portfolio failed because of SVB will have tougher conversations in years to come.4 Cash will flow out of the sector at a point in history when we actually need more, not less, risk capital in the market. (Climate tech ain’t cheap or easy.)
The economic contagion risk. SVB’s clients’ main costs will be staff, services, SAAS and cloud compute. Employees were planning to use their salaries to buy stuff from ordinary people. These startups owe money to lawyers and marketing agencies and SAAS businesses. If these firms aren’t paid, other firms will find themselves in distress. The tech business remains concentrated and specialised, so you could imagine tangible hits to firms of all sizes. And as those firms fail, their suppliers will come under pressure. This is a serious possibility. SVB’s customers are highly concentrated and support a lot of other businesses.