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 why it failed. Lack of diversification means greater risk. But SVB’s focus also has real benefits: it allowed the bank to build a huge amount of tacit knowledge about how startups and venture capital worked. The best outcome would be for a large bank to buy the entire SVB, so that this knowledge is not lost.

In the wake of the collapse of Silicon Valley Bank (SVB), commentators have rightly pointed out the added risk the bank faced because it was so concentrated in one area: venture capital and startups. Less discussed are the benefits that such concentration provided. As regulators, VCs and potential SVB buyers take stock of the collapse, it is important to consider both sides of this coin.

Clearly, SVB’s focus on a single sector increased the risk and is a major factor in its collapse. Its problems began with the large increase in deposits caused by the increase in startup funding. And the hyper-connected nature of SVB’s customers meant that a run on the bank could happen almost instantaneously. If SVB had been more diversified on the deposit and loan side, or if SVB had been a small part of a large financial institution, the banking risk would have been significantly reduced. One of the basic tenets of finance is that diversification reduces idiosyncratic risk.

But that’s not the end of the story. It’s also worth recognizing the huge benefits of specialization that have allowed SVB to become such a powerhouse for startups. Having personally known SVB and much of its senior management for over 30 years, I know well 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 their needs. From corporate debt lending to cash management for startups and VCs to wealth management for young wealthy entrepreneurs, SVB has focused on understanding the entire capital lifecycle within the startup ecosystem and designed a business to address the myriad needs of the community .

And this model proved valuable far beyond the geographical boundaries of Silicon Valley. SVB had a significant presence in the Israeli and European tech communities because they truly understood the needs of the startup industry. Through its fund of funds, the bank has been a major investor in many of the leading venture capital firms, providing SVB with important insights into underlying investment trends. The information gathered through these limited partner shares was useful in being able to collaborate and provide credit and other services to start-ups. This has been a big boon for the startup ecosystem.

Similarly, SVB’s deep relationships with both VCs and companies could be a source of significant networking opportunities for both entrepreneurs and investors. The products and services that SVB could offer evolved over time to meet the needs of the rapidly changing technological landscape. SVB has been a critical part of the ecosystem and has been incredibly important in helping the industry mature and grow. Because she had personal insight into companies and founders through her extensive network, she could operate quickly and efficiently.

The most likely outcome of SVB’s collapse appears, as of this writing, to be the sale of various pieces 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 science and other deep technology, will become harder to obtain and more expensive. This will slow down the pace of technological development and likely lead to the closure of more businesses. Cash management will become more complex as companies raising large amounts of capital now distribute that cash across many different banks. The role of the startup CFO will become increasingly important (and more complex). VCs are likely to pay more attention to startup cash balances and may focus on smaller, segmented investment rounds that lead to more complexity and hurdles for startups. Valuations and the pace of investment are likely to be affected as well. 2022 was a year of reset in the world of startups and technology. The collapse of SVB will 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? Some of that depends on what happens with the SVB business. There will certainly be banks stepping in to do the various pieces of what SVB did. There are private debt providers going around to bid on the loan portfolio. Other financial firms are looking to buy parts of SVB, such as wealth management. Many of the big banks have long wanted to have a bigger presence in the startup world. Serving startups can lead to lucrative IPO underwriting and other services. So yes, the VC and startup sector will have a lot going for it.

But having so many tentacles in the industry has allowed SVB to build decades of embedded knowledge of the industry’s people, issues and evolving needs. This will not be completely copied by other banks. Unless someone bought SVB as a whole, I don’t think any bank will take the role in the ecosystem that SVB did. While the products and services can be replicated at larger financial institutions, much of SVB’s tacit knowledge was embedded in the people and networks it had built. It will be almost impossible to reproduce them in pieces.

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

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