Silicon Valley Bank (SVB) failure & ripple effect on global tech startups; What you should know and what every startup CEO/CFO should do!
Crisis management for every startup impacted
Earlier this week, when the scare of a sun set on California-based bank; Silvergate was rumored, it was largely excused by the volatility of cryptocurrency — another aftermath of Sam Bankman-Fried’s FTX brutal blow on the hippy world — which has led to continuous panic and non-stop withdrawal requests from customers. Many antagonists of digital currency and cryptocurrency believed this could not happen to any of their favourite long-established banks insured by the FDIC.
Just as the world was catching some breath of relief, it woke up to another nightmare; the largest bank failure since the 2008 financial crisis — the failure of Silicon Valley Bank (SVB). This failure, which most people have accredited to incompetent treasury management and an unfavorable monetary policy regime, increased withdrawal requests due to an increase in cash burn (operational or capital expenses or the liquidity need of a startup) from key customer segments that consist of startups (SBV banks nearly half of all venture-backed tech and life science companies in the US) that have deposited millions of dollars raised from VCs and other institutional investors.
What led to the SVB failure?
What exactly was SVB doing in the banking business?
The banking business model is as simple as receiving deposits from customers, lending them out, receiving interest on the loans, then paying back some of the interest earned and a share of this income to depositors as the cost of funds. That simply means every dollar deposited at a bank is a liability to them, and banks owe customers an additional fee for each dollar deposited. Asides the cost of deposits owed to customers, the bank has to cater to overhead costs and every other cost required to run the bank, which means banks have to ensure they earn considerate returns on the deposits for going-concern sake.
Due to the risk attached to lending, banks often and legally use these deposits to buy low-risk securities and investments with yields and returns sufficient to cater for their cost of funds and other operational expenses and, in the end, make profits.
Simple, yeah? What can go wrong?
Heightened innovation, hot venture capital investments, and crypto FOMO increased deposits into the SVB as its target audience, which is largely tech startups, flourished. This boost more than tripled SVB’s deposit liabilities, and as they grow, a good problem emerges: how will the bank pay the cost of these deposits? Lend more? Too risky! invest more? Security assets must be chosen carefully to match liquidity obligations!
SVB decided to invest more (more than $90 billion) in low-risk securities such as Treasury bills, bonds and Mortgage-backed assets. As safe as these assets are, they are largely tools of economic planning which means they are impacted by government monetary policy changes. Recall that to make this strategy work, they must carefully match liquidity obligations. That was the first mistake made by SVB, it didn’t envisage a huge withdrawal request - it invested in 10+ year-tenor assets.
Trouble knocked when the Feds hiked rate to combat inflation, this simply means the returns on these assets decreased while they now would need to pay higher to match the value of those assets at the time they were deposited. This risk was heightened when startups started facing huge paucity in VC investments, decline in revenue and the crypto winter resulting in dearth of many startups, unprecedented lay offs among other troubling incidents since 2022. This increase in “cash burn” by startups need more money and increased access to their deposits - SVB was over levered and cannot produce these cash when needed hence it needed to either liquidate all its investments (which it means SVB will lose a lot of money) or raise more capital to solve this fix.
The beginning of the end
According to its Strategic Action filed with the SEC, the bank said it had sold all its available securities worth over $21 billion with an estimated loss of $1.8 billion to ensure it has enough equity for going concern, i.e., the ability to fulfill all its obligations and continue to run as a business. On March 8, SVB announced in a letter to its investors a proposed offerings of common stock and mandatory convertible preferred stock, it intends to offer $1.25 billion of its common stock and $500 million of depositary shares, consisting of 10 million depositary shares each representing a 1/20th interest in a share of its Series F Mandatory Convertible Preferred Stock (“Preferred Stock”), liquidation preference $1,000 per share (equivalent to a liquidation preference of $50 per depositary share), in separate underwritten registered public offerings.
This drama made people freak out at the losses, and this triggered the game of who withdraws their money last. More withdrawals, more liquidity problems, more withdrawals, THEN SILICON VALLEY BANK FAILS!
The California Department of Financial Protection and Innovation on Friday said it has taken possession of Silicon Valley Bank. The reason, it said, was "inadequate liquidity and insolvency."
Asides from incompetence, SVB failing for me is an indication that Deposit Insurance Corporations aren’t effective and Banks should rather embrace more “Trustees-Custodian” approach to Treasury Management. FDIC globally only insures a fraction of all deposits (up to $250,000 per depositor), this means any startup with balance more than that would have to make do with $250K for the time being.
The impact of this is huge as tons of “startups” may crash and even tens of thousands “may” be out of jobs by the end of the weekend if Feds/Min of Fin doesn’t step in immediately
What should every startup CEO/CFO impacted do?
At a time of panic, every ethical line is tested. Most founders are going to commit honest ethical mistakes and blunders due to the SVB because they want to save their company. It’s important that all actions are scrutinized and advised by legal counsel. Don’t hastily wire funds to personal accounts; don’t hastily make irrational decisions on firing or even breaching contracts and agreements.
Instead, a founder should build a roadmap towards survival by;
Reviewing and refactoring all receivables.
Review your business model to consider prepaid payments from users.
Review all payables, grade and negotiate terms. Only pay only showstoppers immediately then negotiate deferred payments with others.
Plan with the DIC guaranteed cash of $250k.
Instead of firing every employee, work with them to create a plan: defer not cut salaries, execs take the highest % deferment.
Communicate to who matters; Write, call employees, investors, suppliers etc.
Get a crisis communication expert to talk to your users. Be honest!