What SVB collapse should teach us about managing risk

SVB collapse
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I have written annual forecasts for Disruptive.Asia for some years now. I also try to forecast things about the VC, startup and finance market. But I must admit the collapse of Silicon Valley Bank (SVB) is something I didn’t see coming. It has been an institution in Silicon Valley and looked stable – until suddenly it wasn’t.

But this is a good reminder of how rapidly things can happen and how everything is linked.

It also raises some obvious questions: Can we learn something from the SVB collapse? Is this something we could have predicted? Could we have been better prepared for it?

Don’t bet on individual companies

Four months ago, I wrote about risk management, especially for supply chains, geopolitics and country risks, and compared it to portfolio management. I mentioned my portfolio management professor years ago who warned us that even the best companies fail one day. He also said to forget about trying to guess who is doing well, who is lucky, or who has the right timing. Do the math and diversify your portfolio.

I also wrote that if you’re looking at your investment portfolio and you see that tech shares are now risky, but banks make better money with higher interest rates, you might think, “Okay, let’s move all the money from tech stocks to bank stocks.” That might be a good move for a while, but it’s not really professional risk management or portfolio management. We tend to make educated guesses. But educated guesses are still just guesses.

When I wrote that, I hadn’t the slightest idea that just four months later SVB would collapse. But it proves the point: it’s very hard to predict how an individual company will fare. This is why you must do your math, and diversify your portfolio. And, as I wrote, this doesn’t just mean to diversify your investments, but also your supply chain, sales markets and operations, and where you keep your money.

Of course, you must always find a balance between risk and return. Sometimes you need to take a higher risk, but you also need to recognize it as such.

SVB was a trusted partner

Most consumers have never heard of SVB; neither have that many businesses outside of Silicon Valley. But that doesn’t mean its collapse isn’t a big deal. It’s huge, in fact. SVB has been an institution for venture capitalists, startups and anyone working with growth tech companies.

I remember many stories from SVB. For example, a startup was running out of money – it had a well known venture capitalist as an investor. He simply placed a call to SVB and it immediately organized a bridge loan for the startup to pay salaries and other mandatory costs until it was able to close its next funding round. This story tells a lot about SVB – it was a trusted partner for startups and investors, and an important part of the ecosystem.

It is still hard to say what will be the total impact from its failure, but we can assume it is having a far bigger impact on VCs, tech investments and startups than the financial ecosystem as a whole. Many VC’s and startups kept their money at SVB.

But maybe an even bigger question is why it failed and what its failure tells us about the tech sector.

Tech valuations are part of the SVB story

Technically we can name all kinds of finance-instrument-related reasons for its failure. For example, SVB had bond instruments with low value and it was hard to sell them. It was also a very traditional banking crisis panic culminating in a bank run, with customers suddenly transferring their money to other banks. Also, thanks to digital services, the transfers happened fast.

But we also should look at the situation of tech companies, their investments and company valuations lurking in the background, which has an important impact on all this.

It’s also important to remember that SVB didn’t take just any startup as a customer. It wanted to focus on well-funded companies that were typically at least in the Series A phase and often got money from the best known VCs – many of whom were also SVB customers, as well as investors and startup founders.  

At the end of 2022, the vast majority of the bank’s deposits – $157 billion – were held in just 37,000 accounts, with an average over $4 million in each account. That’s very different from normal bank accounts and much more than the FDIC’s (Federal Deposit Insurance Corporation) $250,000 guarantee.

So, when you start to have problems with those kinds of customers, we can conclude something about the current market situation. The valuations of tech companies have been dropping for over a year now, and this has had an impact on the VC market too. So, it’s been a tough time for companies who had already raised a lot of money with high valuations if they need more money. And those types of startups and founders have really been SVB’s sweet spot.

Everything is connected

It’s interesting that another bank collapsed around the same time as SVB – Signature Bank, which was heavily involved in crypto and took crypto customers. Like SVB, it was also linked to businesses that are now in trouble. It was also linked to the tech investment world and – indirectly– to SVB’s problems.

Which brings us to another topic I have written about: network analytics, in which we should not only analyze individual companies, countries or industries, but how things are linked to each other.

Network analytics is relevant for cases like SVB. If we just analyze SVB totally independently from everything else, or even in the context of general situation in the banking sector, things don’t look so bad. But when you look at SVB’s links to tech companies, VC funding rounds and their valuations, especially for startups that have raised big money and have passed Series A, the picture is quite different.

When we take those kind of links into consideration, it’s possible to see that SVB’s risk level rose rapidly, and that it would have needed very cautious risk management activities. And of course panic also spread in the networks, so that would be one area to monitor too.

Hard times ahead for funded startups

It is often said that difficult times are the best time to build companies that will be really successful and sustainable. It is probably true now, too. But this situation is very tough for companies that were able to raise money with high valuations in 2019 to 2021, but their revenue and profit currently don’t justify new funding rounds, or their valuation is now much lower than it was. SVB’s collapse makes their situation worse.

At the same time this could be an excellent moment to build a startup with smaller funding and really focus on basic things: get the product to work, make customers happy, go step by step and don’t try to scale up too early.

If nothing else, it’s a reminder that it’s hard to predict the market, and especially individual companies. You must properly diversify in all things and understand your risks. It is also fundamental to understand how things are linked to each other – how events somewhere can create a risk for you, even if they are not directly linked to you.

There are actually quite a lot of models to evaluate this, though we probably need more actionable tools to estimate things. But more importantly, we especially need take those calculations seriously. If we just go based on our own intuition, we quite often encounter bad surprises. Good times can create the illusion that you don’t need risk management. But bad times always come, and you must know how to survive them, too.

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