Silicon Valley Bank is 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 allows the bank to build a large amount of tacit knowledge about how startups and venture capital work. The best result is to buy a large bank of the entire SVB, so that the knowledge is not lost.
In the wake of the collapse of Silicon Valley Bank (SVB), commentators have rightly highlighted the increased risk the bank bears by concentrating heavily on one sector: venture capital and startups. Less talked about are the benefits that such concentration provides. As regulators, VCs, and potential buyers of SVB examine the collapse, it is important that both sides of that coin be considered.
Clearly, SVB’s focus on one sector increases risk and is a major factor in its collapse. Its problems started with a huge increase in deposits due to an influx of start-up funds. And the hyperconnected nature of SVB’s clients means that bank runs can happen almost instantaneously. If the SVB is more diversified in terms of deposits and lending or if the SVB is a small piece of a large financial institution, the risk of a bank run can be minimized. One of the basic principles of finance is that diversification reduces idiosyncratic risk.
But that is not the end of the story. It is also worth recognizing the many benefits of specialization that allow SVB to be strong for startups. Having personally known SVB and most of its senior management for over 30 years, I know what the focus on venture capital and tech startups means for the industry. SVB focuses on and understands the needs of the startup community, offering products and services tailored to its needs. From venture debt lending to cash management for startups and VCs to wealth management for newly wealthy entrepreneurs, SVB focuses on understanding the entire capital lifecycle within the startup ecosystem and designs businesses to address the many community needs.
And this model has proven valuable far beyond the geographic confines of Silicon Valley. SVB has a large presence in the tech communities in Israel and Europe, because it truly understands the needs of the startup industry. Through its fund of funds, the bank is a major investor in many of the leading venture capital firms, providing SVB with important insights into underlying investment trends. The information obtained through these limited partner stakes helps to work and provide credit and other services to startups. This is a huge boon to the startup ecosystem.
Similarly, SVB’s deep relationships with VCs and companies can be a source of valuable networking opportunities for entrepreneurs and investors. The products and services that SVB can offer have evolved over time to meet the needs of the rapidly changing technology landscape. SVB is a critical part of the ecosystem and very important for helping the industry mature and grow. Because it has personal insight into companies and founders through its extensive network, it can operate quickly and efficiently.
The most likely outcome of the collapse of SVB seems, as of this writing, to be a sale of various pieces of the bank to several buyers. When that happens, startups suffer. Debt financing, which many startups use to finance the development of cleantech, life science, and other deep technologies, will become more difficult to obtain and become more expensive. This will slow down the pace of technological development and will likely lead to many companies closing down. Cash management becomes more complicated as companies that raise large amounts of capital now spread that cash across many different banks. The role of the startup CFO can be more important (and more complex). VCs tend to pay more attention to startups’ cash balances and may focus on smaller, tranched rounds of investment that lead to more complexity and hurdles for startups. Values and the flow of investment are likely to be affected as well. 2022 is a year of reset in the startup and tech world. The collapse of SVB will make it difficult to maintain normal funding.
What should the world expect from the start ahead? Can we have the best of both worlds? Some of it depends on what happens in SVB’s business. Certainly there are banks that operate to do different parts of what SVB does. There are private debt providers circling around to bid on the loan portfolio. Some financial companies are looking to buy pieces of SVB, such as wealth management. Many of the big banks have long sought to gain a greater presence in the startup world. Serving startups can lead to lucrative IPO underwriting and other services. So, yes, the VC and startup sector has places to go.
But having so much industry expertise has allowed SVB to build on decades of embedded knowledge of people, issues, and evolving industry needs. That cannot be fully replicated by other banks. Unless someone buys SVB as a whole, I don’t think any bank will take the role in the ecosystem that SVB has created. While products and services may be copied by large financial institutions, much of SVB’s tacit knowledge is embedded in the people and networks it forms. That was almost impossible to copy in pieces.
The failure of SVB raises difficult questions about the role of midsize, specialized banks. They present unique risks that must be mitigated. But as SVB describes, they also provide significant benefits. In this case, the least disruptive solution and the one that would retain most of the benefits of SVB’s specialization would be to sell the entire bank and for the bank to continue to offer the types of services it has historically provided. , although there is a less risky balance. If someone at the FDIC is listening, I believe that is the best option for value preservation.