Bailing out Silicon Valley (Bank)

posted: March 18, 2023

tl;dr: My experience with the venture capitalists’ bank, Silicon Valley Bank...

Twenty-five years ago I was a co-founder and key executive at a startup company, Oresis Communications, that banked at Silicon Valley Bank (SVB). At the time, Silicon Valley Bank was about fifteen years old, and it would grow into one of the twenty largest banks in the United States. SVB’s growth was propelled by the growth in the venture capital industry as well as some of the companies that SVB banked early in their existence. On March 10, 2023, the Federal Deposit Insurance Corporation (FDIC) declared SVB to be insolvent and took it over. Over the weekend, the Federal Reserve, the Treasury Department, and the FDIC came out with a bailout plan that made all depositors whole, even those who had much more than the FDIC’s insurance limit of $250,000 in their cash accounts.

Make no mistake about it: Silicon Valley Bank existed because venture capitalists (VCs) wanted it to exist. It truly was their industry’s bank. A spirit of co-opetition exists in the VC industry: each VC is a managing partner of a separate fund, but they cooperate to get deals done and to help their portfolio companies. That’s where SVB came in: by focusing on the venture-backed startup industry, SVB could develop close relationships with the VCs backing those companies and then help those companies by providing banking services.

A pre-revenue startup company looks very different from an established company, as the former’s continued survival depends more on selling stock to investors (i.e. VCs) in the future than on selling products to customers. Traditional banks were wary to take on startup companies as clients: how would they be able to know if a company selling Bored Ape Yacht Club Non-Fungible Tokens was going to be in business in two years, and hence deserved a loan or to accept credit cards? SVB bank officers could just call up some VCs that they knew and ask them “is this company headed for success or, at least, more funding?” After all, the VCs were on the board of directors. SVB kept venture money in the venture community: the money came from VCs, but once companies received it and deposited it in SVB, it was a pooled resource available to the venture-backed startup community.

In the upper left, a blue box containing the lower-case letters s, v, and b in white; in the upper right, a darker blue box containing a white greater-than symbol; on the bottom an even darker blue box containing the words 'Silicon Valley Bank' in white lettering

Oresis received seed financing very early in its existence, when we were still working out of the basement of one of the other co-founders. I think we became a Silicon Valley Bank client after the first major round of funding. I can’t remember if it was a condition of receiving that funding that the company deposit it at Silicon Valley Bank. Even if it wasn’t, we would have done so anyway. Silicon Valley Bank had a certain cachet associated with it, as did the top tier venture capital firms that initially backed the company ( Bessemer Venture Partners and Lightspeed Venture Partners, which arose from the venerable Weiss, Peck, and Greer firm). Oresis was based in the Portland, Oregon area, a short plane flight to Silicon Valley but a remote outpost in terms of the amount of venture financing activity. Having these firms behind the company provided credibility to prospective customers and employees.

We kept the money we had raised mostly in safe, short-term bonds, and converted it into cash only when we needed to pay some bills or payroll. Silicon Valley Bank also provided money to Oresis in the form of a collateralized equipment loan. When we bought equipment such as office furniture, lab equipment, and computers, we could use the equipment loan to do so instead of having to tap into the money we had raised. We paid some interest to SVB for this loan, but the theory was that we would raise money to pay it off in the future at a higher company valuation. The equipment loan therefore helped reduce equity dilution for the company’s employees (who had stock options) and the early investors, the VCs.

I do remember SVB going through some tough times when the dotcom bubble burst. Many of those equipment loans never were paid back, as the companies who received the loans went bankrupt. But somehow SVB survived. So I was a bit shocked to see them go under a week ago.

The primary reason Silicon Valley Bank went under is that they bet far too heavily on low interest rates persistently ad infinitum, and loaded up on long-term Treasuries and mortgage-backed securities, classifying many of them as “Hold To Maturity” securities (a complete joke, in retrospect). Long-term bonds are toxic assets in times of inflation and rising interest rates, as anyone who was alive and paid attention in the 1970s knows (SVB was founded in 1983). SVB failed to follow my lead in May 2020 when I dumped all my bonds; instead, they were on the other side of the trade, buying them up. Now they are bankrupt and I am not. I can’t blame them for not realizing what was going to happen in May of 2020. I was definitely ahead of the curve, but it should have become more obvious as time went on, inflation set in, and interest rates rose. But apparently SVB had no Chief Risk Officer, who is the person who is supposed to spend his or her days asking one of my favorite questions: “What could possibly go wrong?”

To compound the stupidity at the bank itself, there was rampant stupidity among the bank’s depositors as well. Most of the deposits at SVB were uninsured because account cash balances exceeded the FDIC’s $250,000 guarantee. Roku, for example, had $487 million at SVB, most of it uninsured. What idiot does this? Roku’s CFO should be immediately fired for not knowing how to ladder T-bills.

The U.S. government decided to reward all this stupidity by retrospectively guaranteeing all deposits, to bail out depositors. The moral hazard should be crystal clear, but many do not see it. VCs could have personally stepped up and provided capital to the bank to keep it going: there is plenty of wealth in Silicon Valley. If the VCs were unwilling to save the bank, and depositors lost money, then VCs would have had to write more checks to replenish the cash at their favorite portfolio companies. Maybe a few portfolio company CFOs would have been fired for being as stupid as Roku’s CFO. Instead, depositors in the VCs’ favorite bank were bailed out without a single VC having to write a single check. It was a huge win for the venture capitalists.

I’ve accepted the fact that we’ve migrated far away from free-market capitalism. The Silicon Valley Bank episode is just another indication that we’re now operating in a system of State-directed capitalism.