SVB's failure exposes lurking systemic risk of tech's money machine
Many private equity and venture capital firms found themselves facing the same counterparty risk, creating a frenetic weekend before federal intervention.
The collapse of Silicon Valley Bank has prompted a global reckoning at venture capital and private equity firms, which found themselves suddenly exposed all together to the tech industry's money machine.
SVB billed itself as a one-stop shop for tech visionaries — more than just a bank, a financial partner across loans, currency management, even personal mortgages. Its tactics to bundle client services were deemed aggressive by some, but it was hard to argue with the results: business with 44% of venture-backed technology and health-care companies that went public last year, and overall explosive growth during boom times.
In so doing, it created massive counterparty risk — a single point of failure that could imperil the sprawling financial ecosystem that backs America's next big ideas.
Private equity firms including Vista Equity Partners, Insight Partners and Thoma Bravo have dozens of portfolio companies that banked with SVB. It was the institution of choice for startups backed by the region's most prominent venture firms, like Sequoia Capital and Andreessen Horowitz. And it provided services to Roku Inc. and other public companies long after their IPOs.
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It's a startling wake-up call to regulators after largely standing by as the shadow banking system ballooned in the wake of the global financial crisis. Private equity firms invested more than $6 trillion in the US economy in the 10 years through 2021 and employ more than 11.7 million Americans. Venture capital money more than quadrupled from 2007 to 2021, to about $1 trillion, and VC-backed companies have 3.8 million workers — a 960% increase from 1990.
After days of frenetic contingency planning in the venture capital world, US financial regulators laid out a plan on Sunday to protect depositors' funds after SVB's demise. The Treasury Department, Federal Reserve and Federal Deposit Insurance Corp. jointly announced the efforts, which include a bank funding program invoked under the Fed's emergency authority.
The program allows banks to place Treasuries, which have declined sharply in value over the past year, at the Fed and receive face value back in the form of a one-year loan. It was large unrealized losses on such securities, combined with unstable deposits, that doomed SVB.
For now, US private equity and venture capital firms are breathing a cautious sigh of relief, though questions remain about how SVB will ultimately be wound down. There was a similar sentiment in the UK on Monday after HSBC Holdings Plc said it was buying SVB's British arm for £1 ($1.21), the culmination of a hectic weekend where ministers and bankers explored various ways to avert its collapse.
"Glad we didn't have to learn the hard way, but this is still a reminder of the dangers when we become too dependent on a single point of failure," said Darren Eng, a venture capital adviser and executive director of Los Angeles's venture association. "The ecosystem shouldn't be beholden to just one bank."
'Dialing for Dollars'
Venture capitalists, founders and executives spent the weekend developing plans for startups with tied-up funds. Some deep-pocketed firms, including General Catalyst and Khosla Ventures, offered to help portfolio companies cover payroll.
Ari Newman, co-founder of Massive Capital Partners, was "dialing for dollars" to help his portfolio companies find the funds to make payroll. On Sunday evening, after the government's announcement, he said he had no regrets.
"I did the right thing to protect and support my portfolio and I'd do it again," Newman said. "Waiting to see what happens was not the responsible perch for me as an investor."
SVB's vast reach was laid bare to Joshua Frost, Treasury's assistant secretary for financial markets, as he addressed a virtual audience of almost 1,000 venture capitalists and their portfolio companies on Friday evening.
During a members-only Zoom call, representatives of the lobbying group National Venture Capital Association threw question after question at Frost, who would later that evening speak with FDIC officials. They implored him to consider the industry's view when officials crafted a response.
"The magnitude of what this industry is responsible for, and on behalf of the country, this is significant," said NVCA president Bobby Franklin. "This is where the innovation happens."
The same day, some 20 private equity CFOs and executives with exposure to SVB jumped on a call. Some said that if it became clear deposits weren't secure at smaller institutions like SVB, they would stop parking assets in them altogether, said a person briefed on the call.
Black Hole
Meanwhile, institutional investors were rushing to make sure they weren't sending money into SVB's black hole.
In the back offices of some of the nation's biggest public pension plans, employees on Friday were checking that funds for capital calls weren't being wired to accounts tied to SVB, according to a person familiar with the matter.
The same exercise was playing out among investors in New York-based Insight Partners, where about 50% of portfolio companies had a banking relationship with SVB, said people familiar with the matter. It had made a capital call just days before the bank's collapse, and had to abruptly change the transfer location for the money due in the coming week.
Others weren't nimble enough. One startup that took out a loan with SVB had to agree not to open other accounts with a US bank as a condition of borrowing, said a person familiar with the matter. That left the company unable to get out, for fear of breaching a covenant.
That startup was hardly alone. In calls with potential clients, SVB's sales team would often cross-sell different services, and a conversation about a regular business bank account would turn into a conversation about how the bank could provide venture debt, or even open personal accounts for founders, said a person who heard the pitch in the past month. Bank representatives would lower rates on debt the more a business had on deposit.
Some considered it aggressive banking. Others saw it as a reflection of Silicon Valley itself — taking big swings on risky ventures when others wouldn't.
Trust Involved
"SVB would provide venture debt for companies that sometimes don't have revenues or millions in revenue at a very good price," said Jai Das, co-founder of Sapphire Ventures. "There was a lot of trust involved."
Sequoia's Michael Moritz likened losing SVB to "having a death in the family" in an article Sunday in the Financial Times.
"The fates of thousands of small technology companies and the vitality of the start-up economy will be back in the hands of strangers," Moritz wrote. "And the US will be all the poorer."
SVB wasn't the only financial institution the tech industry patronized, of course, but it was a clear leader in the market. So much so that banking there was something of a badge of honor among venture capitalists.
Its collapse leaves a void in the industry that in the immediate aftermath will likely be filled by multiple banks.
"What would be best for the ecosystem is for a half a dozen banks all partnering with early stage tech entrepreneurs and investors," said Scott Jacobson, a managing director at Madrona Venture Group, adding that Jamie Dimon's JPMorgan Chase & Co. has been investing in its tech relationships. "Now there's an opportunity for others to fill the hole. Many would be welcome."
Scott Shane, a managing director at Cleveland-based Comeback Capital, bristles at the idea that making those with deposits at SVB whole amounts to a bailout of rich venture capitalists. His firm invests exclusively in companies outside the Bay Area, in cities like Omaha, Nebraska and Tallahassee, Florida.
"People don't really actually understand," Shane said. "Startups are everywhere."
On the other side of the world, Haseeb Qureshi, managing partner at crypto venture capital firm Dragonfly, found out about the federal government's backstop in his hotel room in Dubai, where he's on a business trip. He woke up in the middle of the night, anxiously scrolling his phone and tracking developments around SVB.
Without any action, "it was going to be blood in the streets," Qureshi said.
And now?
"There's a lot of emojis," he said of his texts with Dragonfly's portfolio companies. "A lot of elation and relief."
— With assistance by Hema Parmar, Ellen Huet and Tom Metcalf
Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.
