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

Silicon Valley Bank focused on the startup sector, and that’s part of the story of its failure. Lack of diversification means greater risk. But SVB’s focus also has real benefits. it allowed the bank to gain vast knowledge of how startups and venture capital worked. The best outcome would be for a big bank to buy SVB in its entirety so that this knowledge is not lost.

After the collapse of Silicon Valley Bank (SVB), commentators rightly highlighted the additional risk the bank carried by being so heavily focused in one area: venture capital and startups. Less discussed are the benefits of such concentration. As regulators, VCs and potential SVB buyers evaluate the collapse, it’s important to consider both sides of that coin.

It is clear that SVB’s concentration on one sector increases the risk and is the main factor behind its collapse. Its problems began with a large increase in deposits, which resulted from an increase in funding for startups. And the hyper-connected nature of SVB’s customers meant that bank runs could happen almost instantaneously. If SVB had been more diversified in terms of deposits and lending, or if SVB had been a small part of a larger 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 the story does not end there. It’s also worth noting the huge benefits of specialization that allowed SVB to become such a force for startups. Having personally known SVB and much of its senior management for over 30 years, I know first-hand what the focus on venture capital and technology startups means to the industry. SVB focused and understood the need 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 nouveau riche entrepreneurs, SVB focused on understanding the entire lifecycle of capital in the startup ecosystem and designed a business that would meet the myriad needs of the community.

And this model is valuable beyond the geographic boundaries of Silicon Valley. SVB had a strong presence in the Israeli and European tech communities because it truly understood the needs of the startup sector. Through a fund of funds, the bank was a major investor in many of the leading venture capital firms, providing SVB with important insights into key investment trends. The information gathered through these limited partner stakes was useful for working with start-ups and providing credit and other services. This was a huge boon for the startup ecosystem.

Similarly, SVB’s deep relationships with both VCs and companies can be a source of important networking opportunities for entrepreneurs and investors alike. The products and services that SVB could offer evolved over time to meet the needs of a rapidly changing technology landscape. SVB was an important part of the ecosystem and incredibly important to the maturation and development of the industry. Because it had personal insight into companies and founders through its extensive network, it could act quickly and efficiently.

The most likely outcome of SVB’s collapse, as of this writing, appears to be the sale of various parts of the bank to multiple buyers. If this happens, startups will suffer. Debt financing, which many startups have used to finance the development of cleantech, life sciences and other deep technologies, will become more difficult to obtain and more expensive. This will slow down the pace of technology development and likely lead to more companies closing down. Cash management will become more complex as companies that raise large amounts of capital will now spread that cash across different banks. The role of a startup CFO will be more important (and more complex). VCs are likely to pay more attention to the cash balances of startups and may focus on smaller, tranched investment rounds, which lead to more complexities and hurdles for startups. Valuations and investment rates are also likely to be affected. 2022 was a year of resets in the startup and tech world. The collapse of 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 that operate to do different parts of what SVB does. There are private debt providers that come around to make offers for the loan portfolio. Other financial firms are looking to buy pieces of SVB, such as wealth management. Many of the big banks have long wanted to have a bigger presence in the startup world. Servicing startups can lead to lucrative IPO placements and other services. So yes, the VC and startup sector will have a place to go.

But having so many tentacles in the industry has allowed SVB to build decades of embedded knowledge of people, issues and evolving industry needs. It will not be completely replicated by other banks. Unless someone bought SVB outright, I don’t think any bank would have taken on the role in the ecosystem that SVB did. While products and services could be replicated in larger financial institutions, much of SVB’s tacit knowledge was embedded in the people and networks it built. They would be virtually impossible to duplicate in pieces.

The failure of SVB raises difficult questions about the role of medium-sized, specialized banks. They present unique risks that must be mitigated. But as SVB shows, they also provide important benefits. In this case, the least disruptive solution, and one that would retain most of SVB’s specialization advantages, would be to sell the bank entirely and continue to offer the types of services the bank has historically provided, albeit with a much less risky balance sheet. If anyone at the FDIC is listening, I think that’s the best way to store value.

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