Failure of Silicon Valley Bank May Foreshadow Innovation Crisis

SVB's fall could have a ripple effect on venture capital interest in startup firms, especially fintechs that rely on outside funding to stay in business. While the failure of one bank is unlikely to have a systemic impact on the broader VC industry, it is one more challenge for startups.

At this writing, it appears that U.S. officials will provide customers full access to their deposits at Silicon Valley Bank starting Monday, in order to avoid further fallout from the largest American bank failure since the 2008 financial crisis. According to a joint statement by U.S. Treasury Secretary Janet Yellen, Federal Reserve Chair Jerome Powell and Federal Deposit Insurance Corp. Chair Martin Gruenberg on Sunday evening, all deposits, including those exceeding the maximum FDIC-insured level of $250,000, will be covered at both SVB and the failed Signature Bank in New York. This move will be paid for by the banking industry, through the deposit insurance fund, and there will be no cost to taxpayers.

Unfortunately, there are still massive challenges for fintech firms and other tech startups, who fretted all weekend after Silicon Valley Bank’s failure about the timing of access to funds beyond the government insured limit of $250,000. These firms reportedly had more than $160 billion in uninsured customer deposits at the bank. Any lengthy delay in access to funds would put an enormous strain on their ability to meet payroll and other obligations and potentially even retain valuable employees.

Global Impact of Silicon Valley Bank’s Failure

The impact of the failure of this highly specialized bank is global in nature since it had independent branches and offices in several countries around the world, including the U.K., Canada, Ireland, Germany, Israel, China, Hong Kong, India, Australia and Singapore. Regulators in each of these countries are working to address liquidity issues impacting the startup economy in their regions.

Silicon Valley Bank was different than most other financial institutions, having a clientele heavily concentrated in the tech sector. In each country, the bank was known for taking a risk on startups that most other banks wouldn’t touch, providing loans despite a startup’s negative revenue stream or lack of significant assets.

Despite how U.S. banking regulators and other regulatory bodies internationally may handle the failure, startups that worked with this bank and other supportive financial institutions will most likely need to look for a broader array of banking partners at a time of tightening liquidity and higher cost of funds. Bottom line, many startups may not have access to the same kind of financing they had with Silicon Valley Bank. This could result in a ripple effect across the industry worldwide as fewer investments are made into fintech firms and other early-stage startups.

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Are Fintech Startups (and VCs) Part of the Problem?

The underlying reason Silicon Valley Bank was shuttered was because it had poor risk management. Instead of short-term securities that would have allowed more flexibility, the bank bought too many long-duration fixed-income securities, causing an asset-liability mismatch, which was exacerbated when the bank’s customers acted en masse to withdraw funds. This “run on the bank” occurred after several venture capitalists used social media to warn tech clients their deposits might be at risk. Making matters worse, digital access to funds meant that the money went out so fast that Silicon Valley Bank was unable to respond quickly enough.

The vast majority of clients of Silicon Valley Bank needed these funds to be accessible for payroll and other obligations. This is because very few of these fintech firms and tech startups operated like typical business, where operating revenue covers expenses. While it’s unlikely this same scenario happens at other financial institutions, the fragility of the technology sector continues to be exposed by higher interest rates, lower availability of venture capital funding options, and the difficulty in generating a positive revenue stream.

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Potential Impact on Future Innovation

The foundation of success for Silicon Valley Bank was that it lent against anticipated revenue as opposed to current business operations. The bank also offered venture debt, which uses a VC investment as a way of underwriting a loan. In many cases, the bank received partial ownership rights (stock) of these tech startups as part of their relationship terms. This worked at Silicon Valley Bank for 30 years. The depth of relationships in the startup sector was massive. About 50% of U.S. venture-backed startups banked with Silicon Valley Bank, according to its website.

The question becomes, will the impact of Silicon Valley Bank resonate across the technology and startup sector for an extended period? In other words, will organizations across the finance ecosystem reevaluate their risk tolerance for innovative startups? And, what firm (or firms) will step up to work with the founders of innovative startups, providing funds as well as business advice and valuable connections to help them succeed?

“It certainly is going to have very substantial consequences for Silicon Valley — and for the economy of the whole venture sector, which has been dynamic — unless the government is able to assure that this situation is worked through.”

— Former Treasury Secretary Lawrence Summers

The impact on innovation will certainly extend beyond the startups themselves. For instance, most tech startups have working relationships with the biggest firms in the business world who, having recognized their innovation and expertise, have outsourced technology needs to them. This includes almost every banking organization that has collaborated with external organizations on their digital transformation efforts. Obviously, the ripple effect on daily operations could quickly spread across the banking (and business) world.

After a period of excessively easy money flowing into the fintech and overall tech sector, we could be entering a period of significant rethinking by investors in innovative startups. This recalibration of investment strategy, combined with continually increasing interest rates, could significantly damage the innovative spirit that has fueled the fintech industry for over a decade.

Read More: What’s Ahead for Banks After the Silicon Valley and Signature Bank Failures?

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