On its last night, Silicon Valley Bank (SVB) hosted venture capitalist Bill Reichert of Pegasus Tech Ventures, who gave a presentation on the topic “How to pitch your WOW! Investors” for about 50 people.
“It was eerie over there,” this is how Mike McEvoy, the CEO of OmniLayers described the event to the Verge. He saw several people leaving the building during the event, who looked subdued.
“Everyone was in denial. The band played on,” Roger Sanford, the CEO of Hcare Health and a self-described “professional Silicon Valley gadfly.”
The next day, the bank that became a symbol of the technology industry was shut down by regulators, making it the second largest bank failure in US history, after Washington Mutual in 2008.
A bank failure occurs when depositors try to withdraw all their money at once, like in Frank Capri’s It’s a Wonderful Life. And as the film explains, sometimes there is not enough cash because the bank used it for other purposes. This was the direct cause of the demise of the most systemically and symbolically important bank in the technology industry.
What is Silicon Valley Bank?
Founded in 1983, Silicon Valley Bank was an important driver of the success of the technology industry and the 16th largest bank in the United States before its collapse.
The bank has worked closely with many startups supported by venture capital funds. It positioned itself as a “financial partner of the innovation economy” and the “go-to bank for investors.” More than 2,500 venture capital firms had accounts there, as well as many technology executives.
The bank collapsed in less than 48 hours.
What will happen to Silicon Valley Bank clients?
Most banks are insured by the Federal Deposit Insurance Corporation (FDIC), a government agency that has been around since the Great Depression. The accounts at Silicon Valley Bank were FDIC insured, but only up to $250,000. That’s how FDIC deposit insurance works, but the US Treasury already announced that all investments of SVB clients will be returned, their funds will be available starting today, March 13.
This will cost the state a tidy sum. The regulator’s recent reporting shows that as of December 2022, about 90% of deposits were not insured. The FDIC says it is “undetermined” how many deposits were uninsured at the time the bank closed.
How bad can things get?
Even small disruptions in cash flow can have major consequences for people, companies, and industries. So while one of the most likely outcomes is that uninsured depositors will eventually be compensated, the problem is that they don’t currently have access to that money.
In the near future, this will affect the payment of wages. Many people wonder if their next paycheck will be delayed. Some already know their salaries will be delayed: Rippling, a workforce management company, particularly in IT companies, has been forced to tell clients that some salaries will not arrive on time due to the collapse of SVB.
With all that, salaries are not the only expenses of the company: there are also payments to providers of software, cloud services, etc.
Does this have anything to do with cryptocurrency?
SVB’s bankruptcy is not directly related to the cryptocurrency crash, but it could potentially worsen the crisis. Cryptocurrency company Circle works with the stablecoin USDC, which is backed by cash reserves – $3.3 billion of which is stuck in Silicon Valley Bank. This stablecoin should be worth $1, but after SVB’s bankruptcy, it lost its peg, falling to 87 US cents. Coinbase has stopped converting USDC to USD.
On March 11, Circle said it “will stand behind USDC and cover any shortfall using corporate resources, involving external capital if necessary.” The stablecoin’s value mostly recovered.
How did this happen?
To understand how this happened, we need to talk about interest rates. They have been quite low since 2008, fueling the venture capital boom, and things have gotten worse during the pandemic. The head of the US Federal Reserve, Jerome Powell, decided to stick to the zero interest rate policy (ZIRP).
According to the latest SVB’s annual report, bank deposits grew as IPOs, SPACs, venture capital investments, etc. went on at a frantic pace.
And because of all these liquidity events, nobody needed loans because they had cash. This is a kind of problem for the bank. Loans are an important way to earn money. So, as explained in more detail by Bloomberg’s Matt Levine, Silicon Valley Bank has been buying government securities. This was a great and stable way of making money for SVB, but it also meant it was vulnerable if interest rates rose.
And it happened. Jerome Powell began raising rates to slow inflation and told Congress his expectations for interest rate growth to 5.75%, which is well above zero.
This is the problem for SVB. It has a bunch of assets that will be worth less if interest rates rise. And it also finances startups, which become more numerous when interest rates are low. Essentially, these bankers managed to put themselves in double trouble that was noticed by several short sellers (a short sale is the sale of financial instruments that the seller does not own at the time of the sale).
When interest rates rose, venture capitalists stopped throwing money around. Startups started taking more money to pay their expenses, and SVB had to look for cash. That meant the bank needed to get liquidity — so it sold $21 billion worth of securities, resulting in an after-tax loss of $1.8 billion. It also made a plan to sell shares at $2.2 billion to strengthen its position. Moody’s agency lowered the bank’s credit rating.
In this presentation that explains it all, Silicon Valley Bank talks about “ample liquidity” and its “strong capital position.”.
Before that, another bank called Silvergate had collapsed (for cryptocurrency reasons). So when Silicon Valley Bank made this announcement on March 8, people ran wild. Peter Thiel’s Founder Fund advised its portfolio companies to exit the bank, yanking millions. Union Square Ventures and Coatue Management, among others, decided to also advise companies to withdraw their money.
This bank run happened quickly, in less than two days.
In the past, you had to physically go to the bank to withdraw your money — or at least suffer the psychological toll of having to pick up the phone. This slow process gave the banks time to maneuver. In this case, digitalization meant the money went so fast that Silicon Valley Bank was effectively helpless, notes Samir Kaji, CEO of the investment platform Allocate. On March 9 alone, customers tried to withdraw $42 billion in deposits — a quarter of all bank deposits in one day.
The next day it was over. The sale of shares was canceled. Then the regulators intervened.
What does this mean for startups?
The venture capital ecosystem exists because banks used to not lend money to startups. A 23-year-old nerd putting together a startup in someone’s garage or elsewhere usually has nothing to put up as collateral against a loan.
One way to support startups in Silicon Valley was to offer risky forms of financing. For instance, the bank lent against money owed to a business’s accounts receivables. Even riskier: the company lent against expected revenue for future services. Silicon Valley Bank also offered venture debt, which uses a VC investment as a way of underwriting a loan. And it worked!
The bank also would get slices of companies as part of its credit terms. For example, at FitBit’s IPO it earned $13.9 million. Most recently, Coinbase’s IPO paperwork revealed that Silicon Valley Bank had the right to buy more than 400,000 shares at about $1 apiece. Coinbase shares closed at $328.28 on the first day of listing.
Startups aren’t the only ones who need to raise money. Venture capitalists also need money. Silicon Valley Bank has invested in a number of venture capital firms over the years, including Accel Partners, Kleiner Perkins, Sequoia Capital, and Greylock.
Many other banks too lose money on their securities. But the gossipy nature of Silicon Valley and the fact that so many of these firms are interconnected made SVB’s bankruptcy more likely than elsewhere.