SVB failure: The ripple effect could trigger a serious innovation and financial crisis


In just a few days, Silicon Valley Bank (SVB) fell from grace so swiftly that it still holds onto ‘buy’ ratings from most analyst firms. A month ago, stock pundit Jim Cramer urged investors to buy the stock—a clear warning sign to anyone familiar with inverse-Cramer investments.  Tomorrow, an estimated 1000 tech start-ups will be unable to make payroll, and a further 2000 will be clinging on to liquidity for dear life.  The future of America’s innovation – and the world’s innovation – is hanging by a thread.

So what actually happened with SVB?

Simply put, SVB piled loads of customers’ cash into long-term illiquid assets that, at the time, were safe but tanked as interest rates increased. That meant they couldn’t lay their hands on enough cash quickly enough to meet withdrawal demands. Word got out; more withdrawal requests came in. Eventually, the whole thing collapsed—a classic run on a bank.

Most of us have seen a run on a bank before. But for those new to the rapid demise of a financial institution, here’s a deeper analogy. Let’s say you’re kicking off a tech startup. SVB’s wooed you with their compelling investment offer for £1m in funding and all the goodies that come with it. Part of that deal involves putting your cash in SVB. They are your bank of choice. SVB, for its part, bought a lot of bonds, dishing out 1.5%. It’s not a bad deal on the face of it, given historically low-interest rates. But then, interest rates started rising. 3, 4, 5%. So those bonds paying out 1.5% suddenly look less attractive than newer bonds getting 4.5%.

Understandably, people aren’t keen on buying them anymore or want a much lower price. These factors combined (SVB pulling below-market yields on its bond portfolio, and the corresponding reduction in the value of bonds) pushed SVB to cash out on billions of bonds at a loss. Then, apparently to reassure the market, they chose to raise new funds from VC firm General Atlantic, alongside a public-facing bond. Rather than reassuring the market, panic set in. Their customers started pulling cash out.

So now, depending on where you are in the queue, getting your cash out of the bank becomes pretty hard. If you’re close to the back of the queue, it becomes impossible.

Some of it’s insured, and some SVB promises to pay back. But, for now, billions of dollars sit in an uncomfortable limbo. Leaving the CFOs of SVB clients to work all weekend as they develop a fiscal survival plan.

Multiply that $1m example a few thousand times, and you have the true scale of the challenge. And that’s assuming it’s just SVB. Global stocks took a kicking at the end of last week, with bank stocks leading the charge. The market is betting that the contagion will spread beyond SVB’s four walls. Most likely due to wary depositors racing to redeem their cash.

Another dent in the tech industry: The ecosystem effect will ripple far beyond tech startups

Now that may be a bit of a simplistic explanation—and economists and equity analysts will no doubt offer countless superior answers—but it gives a flavor of the crisis at hand. Now let’s zoom in on the impact of the SVB crisis on our industry.

Let’s start with the obvious: SVB clients. Firms with cash tied up in SVB face a tough few weeks or months as regulators figure out how to compensate clients and distribute SVBs remaining assets. Already, there are countless stories of tech firms of varying sizes warning that they’ll struggle to make payroll next week.

Few big names have announced any issues, but given its prevalence in the sector, it’s almost certain we’ll see some major enterprise software and services firms touched by the crisis. And, dependent on the direct exposure, we’ll see a ripple effect across the industry.

That’s because SVB’s clients in the enterprise space don’t sit in isolation. Take cloud observability company, Datadog, which is a known client (at least regarding SVB’s published case studies). Amongst their partner ecosystem, Datadog boasts IT Services giants Accenture, Fujitsu, and IBM. If Datadog encounters business continuity challenges—and there’s nothing to suggest they are—, then the ripple effect can swiftly spread across marquee outsourcers and into client engagements.

Of course, larger cornerstone companies (think the big SaaS giants now deeply embedded in most major businesses) will cause significantly larger problems for the industry, particularly as many are already grappling with rightsizing initiatives to drive down unsustainable costs. We could see some significant operational challenges if even a portion of their cash is locked away.

A bigger dent to innovation: A new funding winter

The immediate impact aside, we can expect a more damaging aftershock – a hit to innovation. SVB, as a financial institution, is a crucial source of funding for many high-potential tech firms—many in the consumer space but also a large cohort targeting real-world business challenges. Many will likely struggle to fight through the next few months without access to capital.

These firms may be small and nameless today but could be tomorrow’s enterprise tech giants. We may never know.

The impact is global. For example, TechCrunch reckons 60 YC-backed Indian Startups are struggling to redeem cash stuck in the failed bank. Encapsulating the issue, a founder told the India Express, “It is 4 am now and we have been on hold at the toll-free number given by the FDIC for over half an hour. We have around $2 million in our SVB account and need that to create payroll.” Meanwhile, in the UK, the Chancellor is working on a rapid intervention to provide cash to companies impacted by the crisis and give them some fiscal breathing space.

Smaller companies, or those earlier in their journey, will be the hardest hit. For instance, they’ll find it harder to lean on clients for early payments to help cashflow. And are far less likely to have followed risk best practices by spreading funds across multiple banks. They are also, on average, the source of the greatest industry innovation (today’s SaaS giants, for example, all started somewhere, very few are homegrown in already giant companies).

Bottom Line: The collapse of SVB isn’t just a banking crisis; it’s an innovation crisis

While many look to the collapse of SVB as an inevitable outcome of Silicon Valley excess, perhaps there’s some truth to the characterization. But below the surface, what we have here is the start of a potentially painful period for a tech sector already struggling to make sense of a world alien to their upbringing oriented around cheap cash. But worse, this could be the final nail in the coffin of innovation-focused funding for some time.

While the last decade of easy money deserves a degree of criticism, the inability of traditional investments to offer any meaningful return saw capital flow into startups and innovators. Now, why risk it? When the risks seem much higher, and the comparative returns much lower? And while there are already efforts underway to save SVB, it’s possible the damage to the tech sector is already done.

Posted in : Banking


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