Silicon Valley Bank and how Venture Capitalists Failed Their Founders
Debate whether or not VCs had a role in SVBs failure, but they definitely failed their founders.
Everyone in the startup world knows about (and mourns) the death of Silicon Valley Bank. They were a huge catalyst in the startup ecosystem, helping startups navigate financing, making introductions, and connecting the community. But this came with material benefits for both Founders and Venture Capitalists (VCs).
These material benefits are why VCs ignored that their startup portfolio bank balances were uninsured. VCs certainly knew that billions of deployed capital sat in a single community bank. Not only that, they encouraged it. Why?
What are Venture Capitalists?
Let’s quickly revisit the job of a Venture Capitalist - they take LP (limited partners) money, invest it in high-risk, high-reward startups, and create outsized returns.
Simply put, they are money managers and investors.
Money managers follow the stock market. They watch the Fed. They have podcasts where they talk about it. They are deeply knowledgeable on finance and have a team of analysts to help out. They certainly know that FDIC exists and what it means.
The VC is often considered the “adult in the room”. Founders rely on them to provide advice and mentorship on the business of company building, and most times the weakest area for a founder is finance.
How Did Venture Capitalists Benefit from Silicon Valley Bank?
Chamath on the All-In Podcast was pretty honest about the complexity of how intertwined the VCs were with SVB, and the benefits they received.
SVB is an LP in VC funds. In other words, they invest in VCs, who invest in Founders. They are the VC’s customer.
The VCs personally received friendly terms from SVB for lines of credit, loans & mortgages, often secured against assets that other banks wouldn’t consider.
SVB provided VCs with financial data on startups - how much was raised, valuations, and more. The more startups using SVB, the more data. You can find their public insights here.
SVB was often a (co) sponsor of VC-related events.
SVB was a lead funnel for deal flow.
Let’s add that up - SVB was one or more of: the private banker to VC partners, the bank for the VC company, an investor in the VC, revenue for the VC, provided proprietary data to those VCs, and brought deals to the table.
How did Venture Capitalists Fail Their Founders?
Many VCs instructed their portfolio companies to use SVB and the founders followed because they trusted their investors. They are the money people, right?
Most founders treat VCs with great reverence, particularly when it comes to finance.
If a Venture Capitalist had a role on the board of a startup, and advised that startup to put all of their money into Silicon Valley Bank, you can reasonably argue they failed in their fiduciary responsibility to the company.
They placed their own interests above the interests of the company. The key point by Chamath was that the VC might have been receiving incentives from SVB, which were not disclosed to the founder.
SVB failure wasn’t a sudden and immediate surprise. There are articles that declared SVB effectively bankrupt last September, and a popular site calling out SVB as at risk in December.
In January a trader on Twitter wrote a 10-part thread on why SVB was in trouble.
Not a single VC read any of this? Not a single analyst at a VC firm identified this as a risk? VCs have whatsapp/signal/telegram groups, this was never shared?
The executives at SVB almost certainly would have read these articles, and certainly known they were underwater. None of them shared this at the private valley dinner parties with their VC friends?
That sounds like an abdication of responsibility, powered by drunken ZIRP/Covid excess.
Treasury management is a thing. Regular, boring old businesses do this. But startups and their boards in the Valley ignored it.
What are VCs not Disclosing in the Public Square?
The common refrain from VCs is that the average SVB customer is some scrappy startup working out of a garage eating ramen every day.
No, the vast majority of VC portfolio companies are incredibly well-funded startups that have raised millions in a Series A round (or later stage).
That is who the VCs were protecting when banging the drum for a full backstop of SVB depositors.
Sure, they share the cases of a scrappy startup in Ohio, a school board, a pension fund, and so on.
But the risk to the VCs was clearly their portfolio companies.
Let’s take the average Series A during Covid: a startup raised $15-30M at a post-money valuation of $75-300M, on $1-5M revenue, with little to no due diligence. 2021 was insane.
Then the VC would cheerlead the founder to rapidly drive growth at any cost in order to raise the next round, often called “pre-emptive”. This was great for the VC because they would mark up their TVPI - the paper value of their deployed capital. Then they would use the paper returns to raise their next, much larger, fund.
VCs make their money in two ways - a management fee (typically 2%) on the fund size, and a portion of the proceeds when a portfolio company exits. Imagine a VC that typically ran a fund of $50M, but during Covid they were able to raise a $150M fund. Tripled the management fee!
Fast forward to today and most of these startups are distressed. They don’t have product market fit, they massively over-hired, they are burning cash, and they won’t raise another round any time soon. The party is over.
If SVB was allowed to fail and depositors had to line up as creditors, VCs would have quickly saved their top tier portfolio companies. Maybe helped with payroll for a few of the rest.
But their low quality investments would immediately fail.
Rather than having the deaths spread out over the next 18-36 months, The VC would have to take the immediate write down.
Wouldn’t that give VCs an “out”? Blame SVB for the failure! Well, the question would turn to “why did you save that startup, and not this one?” And the answer would be “under today’s funding terms, we would actually do due diligence and there is no way in high hell we would give another penny to that startup”.
Which then would lead to the LP asking their VC: “Why did you invest in them in the first place?”
Messy.
What Should Founders Take Away?
So as a founder, what can you learn from this shit show?
When selecting an investor, don’t only focus on the best terms. Vet them. Understand their short and long-term goals. Back channel with other founders.
Finance is king. If you run out of money you are dead. Act accordingly.
Get independent experts. If you never heard of FDIC insurance until now, why not? Who in your company or on your board should have covered this?
Get a real CFO, at least part-time. Make sure this person isn’t connected to your board. Ask them about treasury management.
Learn! Just like you learned to code, learned to market, or learned to sell - learn finance.
This was an incredibly scary time for founders. Something that appeared outside their control was just about to kill their startup.
The best founders will recognize they got lucky, take accountability, realize that this was within their control, and learn from it.
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