Silicon Valley Bank’s focus on startups has been a double-edged sword

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 also has real benefits: it enabled the bank to build a vast amount of tacit knowledge about how startups and venture capital worked. The best result would be if a large bank bought up SVB in its entirety, so that this knowledge is not lost.

In the aftermath of the collapse of the Silicon Valley Bank (SVB), commentators have rightly pointed to the added risk the bank took from being so heavily concentrated in one sector: venture capital and startups. Less discussed are the benefits of such concentration. As regulators, VCs and potential SVB buyers take stock of the collapse, it’s important that both sides of that coin are considered.

It is clear that the SVB’s focus on a single sector increases risk and is a major factor in its collapse. The problems started with the large increase in deposits due to a sharp increase in start-up funding. And the hyper-connected nature of SVB’s customers meant that a run on the bank could happen almost instantly. If the SVB had been more diversified on the deposits and loans side, or if the SVB had been a small part of a large financial institution, the risk of a bank run would have been significantly reduced. One of the basic tenets of finance is that diversification reduces idiosyncratic risk.

But that’s not the end of the story. It’s also worth recognizing the huge benefits of specialization that have allowed SVB to become such a force for startups. Having personally known SVB and much of its senior management for over 30 years, I am well aware of what the focus on venture capital and tech startups has meant for the industry. SVB focused on and understood the need of the startup community and offered products and services tailored to its needs. SVB focused on understanding the full lifecycle of capital within the startup ecosystem, from venture capital provision to cash management for startups and VCs to asset management for early stage entrepreneurs.

And this model proved valuable far beyond the geographic boundaries of Silicon Valley. SVB had a strong presence in the technology communities of Israel and Europe because it really understood the needs of the startup industry. Through its fund of funds, the bank has been a key investor in many of the leading venture capital firms, providing SVB with important insights into underlying trends in investing. The information gathered through these shares with limited partners was useful in order to work with and provide credit and other services to startups. This was a great benefit to the startup ecosystem.

Similarly, SVB’s deep relationships with both venture capital funds and companies can be a source of important networking opportunities for entrepreneurs and investors alike. The products and services that SVB was able to offer evolved over time to meet the needs of the rapidly changing technology landscape. SVB was a critical part of the ecosystem and was incredibly important in helping the industry mature and grow. Because she had personal insight into companies and founders through her extensive network, she was able to operate quickly and efficiently.

The most likely outcome of the SVB’s collapse at the time of writing appears to be a sale of several pieces of the bank to multiple buyers. If that happens, startups will suffer. Debt financing, which many startups used to finance the development of cleantech, life science and other deep technology, will become harder to get and more expensive. This will slow down the pace of technological development and likely lead to more companies closing. Cash management will become more complex as companies raising large amounts of capital now spread that money across many different banks. The role of the startup CFO will become increasingly important (and more complicated). VCs are likely to pay more attention to startup cash balances and may focus on smaller investment rounds in tranches leading to more complexity and hurdles for the startups. Valuations and investment pace are also likely to be affected. 2022 was a reset year in the startup and tech world. The collapse of the SVB will only make it more difficult to resume normal financing.

What should the startup world expect in the future? Can we have the best of both worlds? Part of that depends on what happens with the SVB business. There will certainly be banks stepping in to do the different parts of what the SVB did. Private lenders are circling to bid on the loan portfolio. Other financial firms want to buy pieces of the SVB, such as asset management. Many of the big banks have long wanted a bigger presence in the startup world. Nurturing startups can lead to lucrative IPO underwriting and other services. So yes, the VC and startup sector will have places to go.

But with so many tentacles in the industry, SVB was able to build decades of embedded knowledge about the people, the issues and the changing needs of the industry. That will not be fully replicated by other banks. Unless someone bought SVB in its entirety, I don’t think any single bank will take on the role in the ecosystem that SVB did. While its 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.

The bankruptcy of the SVB raises difficult questions about the role of medium-sized, specialized banks. They pose unique risks that must be mitigated. But as SVB illustrates, they also offer important advantages. In this case, the least distortive solution and the one that would retain most of the benefits of the SVB’s specialization would be to sell the bank as a whole and let the bank continue to provide the type of services it traditionally provided, albeit with a much less risky balance sheet. If someone listens at the FDIC, I think that’s the best option for preserving value.

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