The downfall of Silicon Valley Bank is especially troubling because it was the self-described “financial partner of the innovation economy.” The bank, founded in 1983 and based in Santa Clara, California, was deeply entangled in the tech ecosystem, providing banking services not only to a large number of venture-backed technology businesses but also to institutional investors such as venture capital funds and private equity firms. On Friday, 10th March 2023, Silicon Valley Bank (SVB) ultimately succumbed to financial pressures and collapsed, leaving many in the tech startup community reeling.
SVB’s origins can be traced back to the early days of the technology industry in Silicon Valley, when a group of entrepreneurs and investors recognised the need for a bank that could meet the unique financial needs of tech startups. Founded by Bill Biggerstaff and Robert Medearis, SVB opened its first office opened in 1983 in San Jose.
The bank initially focused on providing venture debt and other non-traditional forms of financing to startup companies that were not yet profitable, and it quickly became a popular choice for entrepreneurs looking to raise capital. In 1986, SVB merged with National InterCity Bancorp before completing its NASDAQ IPO in 1988.
Over the years, SVB evolved its offering by providing a range of banking and financial services to tech startups and other companies in the innovation sector, including deposit accounts, loans, credit lines, foreign exchange services, and investment banking services. The bank later expanded its operations beyond Silicon Valley to other innovation hubs around the world, including New York, Boston, London, and Shanghai.
While the bank’s initial strategy was collecting deposits from businesses financed through venture capital, it subsequently expanded into banking and financing venture capitalists themselves, and added services to allow the bank to keep clients as they matured from their startup phase.
According to the company’s website, SVB provided banking services to nearly half of all venture-backed technology and life-science companies in the United States. SVB was also a bank to more than 2,500 venture capital firms, including Lightspeed, Bain Capital and Insight Partners. The bank oversaw the personal finances of numerous technology executives and was a steadfast supporter of various Silicon Valley tech events, gatherings and media organisations.
What could possibly go wrong? Three words – rising interest rates.
To put it plainly, during the tech boom of 2020-2021, SVB garnered an enormous amount of deposits, and as is common for banks, used the cash funds to invest in long-term Treasury bonds. However, with interest rates now substantially higher, the market value of SVB’s bonds is much lower than what the bank initially paid for them.
In addition to suffering notable losses from selling assets, SVB revealed that clients’ cash burn rates did not diminish as anticipated in the present economic climate. Moreover, the scarcity of investments in US startups, which plummeted by 31% to $238 billion last year according to PitchBook, led to businesses withdrawing deposits at a pace quicker than projected for this year.
In essence, SVB allocated a substantial portion of its assets to long-term Treasuries without adequately preparing for the impact of significant outflows in the challenging venture capital industry.
A run on the bank occurs when many clients withdraw their money from a bank, because they believe the bank may cease to function in the near future. As the run on the bank continues, it may lead to a self-fulfilling prophecy, where an increasing number of people withdrawing their funds raises the likelihood of the bank’s default, resulting in additional withdrawals.
On Thursday, 9th March, shares of SVB plunged more than 62% after the company proposed an emergency share sale to strengthen its balance sheet which had suffered a $1.8 billion loss on the sale of US Treasury Bills, due to rising interest rates. Depositors withdrew $42 billion from the bank on Thursday alone despite SVB CEO Greg Becker pleading on a conference call with clients to “stay calm”.
Following the news of an emergency share sale, several venture capitalist firms including Founders Fund, Coatue Management, and Union Square Ventures advised their portfolio companies to withdraw their money out of SVB, contributing to a self-fulfilling prophecy aka a bank run.
SVB shares fell another 66% in pre-market trading on Friday, 10th March, before trading was halted.
Later that day, SVB was shut down by the California Department of Financial Protection and Innovation, citing inadequate liquidity and insolvency. The state regulator appointed the Federal Deposit Insurance Corporation as receiver. The FDIC transferred insured deposits to a new institution, the Deposit Insurance National Bank of Santa Clara. The failure of SVB is the largest of any bank since the 2008 financial crisis and the second-largest in U.S. history.
Implications of the Collapse for the Tech Industry
The collapse of SVB has immediate implications for the cashflow of numerous tech firms in the industry. The FDIC’s seizure of SVB’s $175 billion in customer deposits is alarming, particularly when considering that the regulator only insures deposits up to $250,000. Although seed-stage and Series A firms may find $250,000 sufficient to cover their next payroll, later stage companies face the genuine risk of being unable to compensate their employees. As a result, businesses are urgently seeking ways to decrease their cash burn, and several investors have already witnessed a surge in fundraising inquiries from founders who are uncertain when their frozen funds will become available or how much they can recover.
“For a startup, cash is your oxygen. If you lose that for a few weeks, you can’t pay people, you start losing people,” said Yevgeny Gelfand, an investor at Alumni Ventures.
SVB has also served as a significant source of debt financing for early-stage startups. The ramifications of its collapse will only intensify the need for capital, further complicating matters for these firms.
“Losing one of the stalwarts of venture debt will be a shock for companies, especially those desperate for capital,” said Arjun Sethi, co-founder of Tribe Capital, a venture firm with $1.6 billion in AUM.
The startup ecosystem is heavily reliant on the availability of funding, and the collapse of SVB has dealt a severe blow to the industry. The bank’s prominent role in providing financial services to tech startups, as well as institutional investors, means that its demise could have significant ripple effects throughout the ecosystem, making it even more challenging for startups to secure funding and stay afloat during these difficult times.
Moreover, the collapse of a “systemically important financial institution” like SVB highlights the potential risks facing other banks and financial institutions that are deeply involved in the tech startup space. If more banks were to collapse or experience significant financial losses, it could lead to a broader crisis within the startup ecosystem, with potentially disastrous consequences for the industry and the broader economy.
The collapse of Silicon Valley Bank serves as a stark reminder of the fragility of the startup ecosystem and the importance of having a stable and resilient financial system to support it. As the industry grapples with the fallout from this collapse, it is clear that there is a pressing need for greater financial stability and risk management measures to prevent similar events from occurring in the future.
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