The flood of cash into the tech startup scene in recent years has prompted constant warnings of doom. Most often, this has turned the kind of meltdown that hit Silicon Valley in a century, when the stampede to make money in the early internet led to massive over-investment.
However, it’s safe to say that no disaster scenario describes the kind of financial implosion that occurred this week at SVB Financial, the parent company of Silicon Valley Bank.
As an institution that employs roughly half of local tech startups, the collapse presents a clear threat. This led the head of Y Combinator, San Francisco’s flagship accelerator for early-stage technology companies, to remind some Silicon Valley startups may face an “extinction-level event”.
In many ways, this sounds like a familiar tale in the world of banking: In pursuit of higher returns, SVB failed to address what appeared to be an obvious flaw in risk management. Its assets nearly tripled in three years as capital was poured into the startup and deposited in the bank. SVB puts most of its money into longer-dated bonds to generate higher returns. As interest rates rise, the market value of these investments falls, leaving the bank with losses that, on paper, stood at $15bn at the end of last year.
Instead of selling bonds and taking a hit, SVB hopes to hold its portfolio of low-yielding bonds to maturity, experiencing lower net interest margins. That plan might work. But it emerged this week that the bank’s initial customers, facing more difficult times, have withdrawn their money, forcing the sale of investments and losses. The resulting need for more capital set the alarm bells ringing and led to flight by depositors: According to Friday morning, the regulator should step in and close SVB down.
At the end of the week, it was unclear exactly how this financial shock would affect tech startups with now-frozen deposits. SVB’s excess capital at the end of last year was estimated to be sufficient to absorb notional losses at that stage. Even after a further $1.8bn hit reported this week, the losses still look modest in the context of the total deposit base which stood, in December, at $173bn (although $42bn flew out the door on Thursday alone.)
But losses may increase as regulators carry out forced sales of the bank’s assets. Even more damaging, for many startups, is the risk that much-needed cash will be locked up indefinitely, preventing immediate commitments like staff salaries and forcing some to close their doors.
There is no shortage of people who want to turn this into a Silicon Valley morality tale. For some, it is another example of the hubris of the tech world, and proof that the good times blinded the tech industry to some very real risks. Why, for example, would a public company like streaming video outfit Roku leave $487 million in deposits until now it’s hardly considered a medium-sized bank in the US?
For others, the fallout from SVB’s collapse is a reminder of how Silicon Valley, which has traditionally fought hard to escape heavy government regulation, is quick to seek support from Washington in times of crisis. Tan, the boss of a technology accelerator who warns of extinction, urged tech entrepreneurs to write to local Congressional representatives asking for direct government help.
By the end of Friday, the finger-pointing had also begun. The run on the bank that put SVB low has been held as an example of herd-like behavior often shown by technology investors. Several venture capital firms are inviting companies that have invested in them to take cash from SVB after the bank seeks to raise capital. A partner in one of the leading venture firms told me that the withdrawal caused an unmanageable crisis. Meanwhile, more than a dozen VC companies have banded together to promise to stand behind SVB in the future, if other institutions step to bail out – although some well-known Silicon Valley companies are not part of the group.
Scramble between VCs underlines the dawning feeling that, if SVB is wound up, something irreplaceable can be lost. One investor described the bank as “like the left ventricle” of Silicon Valley’s financial scene – it doesn’t look like the VCs that provide the risk capital that floats the modern tech industry, but is essential to the smooth functioning of the sector. It was established 40 years ago to fill the void left by big banks that often lend to startups. The VC firm that joined on Friday night is hoping that it is not too late to revive the bank. But if it does, Silicon Valley will lose an institution that played an important role in its rise.
richard.waters@ft.com