The recent bank run incident at Silicon Valley Bank left its clients and employees at the affected startups clamoring in chaos. Startup owners and other Silicon Valley Bank account holders raced to explore ways to maintain cash flow even as some of their funds remained inaccessible through the week.
In this article, we take a look at the factors that led to the collapse of a reputed financial engine like Silicon Valley Bank and how you can protect your business as a small business owner or an entrepreneur.
Protect Your Business: Understanding Small Business Banking
Small business banking refers to financial services provided to small businesses by banks and other financial institutions. These services may include checking and savings accounts, credit cards, loans, lines of credit, merchant services, and other financial products.
Small business banking is important because it provides small businesses with access to the financial resources they need to grow and succeed. Small business owners can better track their finances, manage cash flow, and separate business expenses from personal expenses by having a separate bank account for their business transactions.
It can also help businesses get access to credit and other financial resources that can help them grow, buy inventory or equipment, or hire new workers. Many banks also offer online and mobile banking services, which can make it easier for small business owners to manage their finances on the go.
When choosing a bank for small business banking, it’s important to think about things like fees, interest rates, customer service, and the range of financial products and services the bank offers. It may also be helpful to compare multiple banks and read reviews and feedback from other small business owners.
Futureproof Your Business: Understanding Small Business Financing
Small business financing is the term for the different ways that small businesses can get money to start up or grow. There are several options for small business financing, including:
- Small Business Administration (SBA) loans: These are loans that the government guarantees, making it simpler for small businesses to get funding. Traditional bank loans may have stricter terms and higher interest rates than SBA loans.
- Bank loans: Traditional bank loans are another option for small business financing. Banks may offer a variety of loan types, including term loans, lines of credit, and equipment financing.
- Business credit cards: Small business owners can apply for credit cards specifically designed for business use. These cards can provide a convenient way to make purchases and track expenses, and they may offer rewards programs or other benefits.
- Crowdfunding: Crowdfunding platforms allow small businesses to raise funds from a large number of people. This can be a good option for businesses with a strong social media presence or a loyal customer base.
- Angel investors: Angel investors are individuals who invest their own money in small businesses. They may provide funding in exchange for a share of ownership or a percentage of future profits.
- Venture capital: Venture capital (VC) firms put their money into businesses that are growing quickly and have the potential to make a lot of money back. They typically invest larger amounts of money than angel investors but may also require a greater degree of control over the business.
When considering small business financing options, it’s important to carefully evaluate the terms and costs of each option. Small business owners should also consider their financial goals and needs and be prepared to provide detailed financial information to potential lenders or investors to protect themselves.
What Made Silicon Valley Bank Unique?
Silicon Valley Bank (SVB), which is based in Santa Clara, California, is a commercial bank that focuses on helping technology and life science companies. Founded in 1983, it was the 16th largest bank in the US and a key driver of the growth of the technology sector.
Silicon Valley Bank specialized in collaborating closely with numerous firms with VC funding. It made the claim that it was the “go-to bank for investors” and the “financial partner of the innovation economy.” Since its inception, it has grown to become a leading provider of banking and financial services to the innovation economy, with over 2,500 VC firms and numerous tech executives banking there.
Some of the notable events and achievements of Silicon Valley Bank include:
- Acquisition of Leerink Partners, a healthcare-focused investment bank, in 2018 for $280 million, expanding its presence in the healthcare sector.
- Acquiring Boston Private, a wealth management and private banking company, in 2019, for $900 million would also expand its offerings beyond its core commercial banking services.
- Active involvement in a number of high-profile IPOs and financing rounds for technology companies, such as Twitter, LinkedIn, and Uber.
What Went Wrong With Silicon Valley Bank?
Due to the recent turn of events, Silicon Valley Bank collapsed in a matter of 48 hours. Here are some of the factors that led to this unexpected and unfortunate failure:
Spike in Interest Rates
We must discuss interest rates in order to comprehend how this occurred. They have been relatively low since 2008, which led to a boom in venture capital. SVB, like many other banks that lend to startups, has a zero percent interest rate policy (ZIRP).
Do you know what ZIRP does to you if you are, for example, a bank that specializes in startups? According to SVB’s most recent annual report, bank deposits went up as IPOs, SPACs, VC investments, and other activities kept going at a fast pace.
And because of all these liquidity events, everyone had access to plenty of cash and didn’t require a loan. A bank might have a problem with this. Loans are a significant source of income. Hence, Silicon Valley Bank purchased government securities. This was a good and consistent source of income for SVB, but it also left them exposed to an increase in interest rates.
The Silicon Valley Bank was destroyed by a classic bank run that could not be stopped. The Federal Reserve increased interest rates in an effort to curb inflation, and it is predicted that they will eventually reach up to 5.75 percent.
Panicked Short-selling and a Lack of Liquidity
Herein lies Silicon Valley Bank’s issue. It possesses a number of assets that will lose value if interest rates rise. Furthermore, it finances start-up businesses, which are more prevalent when loan rates are low.
A few short-sellers recognized that these bankers effectively managed to get themselves into double trouble. When interest rates increased, VCs stopped distributing capital. Startups began using more of their funds to cover their costs, and SVB needed to find the money to make that happen. It meant the bank needed liquidity, so it sold $21 billion worth of securities at a $1.8 billion after-tax loss.
In order to strengthen itself, it also devised a plan to sell $2.2 billion worth of shares. To add to the woes, Moody’s promptly lowered the bank’s credit rating.
Uninsured Deposits Leading To Further Panic
The Federal Deposit Insurance Corporation (FDIC), a federal organization that has existed since the Great Depression, ensures the majority of banks. Naturally, the FDIC insured the accounts of Silicon Valley Bank, but only up to $250,000. This is how FDIC deposit insurance usually operates.
That amount of money can be substantial for a person, but in this case, we’re talking about businesses. Many have monthly burn rates in the millions of dollars. According to a recent regulatory filing, as of December 2022, nearly 90% of deposits were uninsured. The number of uninsured deposits at the time the bank closed was “undetermined,” according to the FDIC.
Many fled as a result of Silicon Valley Bank’s statement on March 8. Meanwhile, Peter Thiel’s Founder’s Fund pulled millions by advising its portfolio businesses to leave. Indeed, we are aware of how much VCs enjoy following trends! This resulted in Coatue Management and others, including Union Square Ventures, advising businesses to stop taking out new loans.
The Inevitable Bank Run
In less than two days, there was a bank run. That can be attributed to IT nerds. Earlier, you had to visit a bank to withdraw your money physically, or at the very least, suffer the psychological harm of picking up the phone. Because of the delayed procedure, banks had more time to plan.
According to Samir Kaji, CEO of investment platform Allocate, digitization, in this case, resulted in the money leaving the country so quickly that Silicon Valley Bank was practically unable to stop it. On March 9, customers made attempts to withdraw $42 billion in deposits or a quarter of the bank’s total deposits.
The following day, it was over. The stock offering was shelved. The Silicon Valley Bank made an effort to rebrand. Then the authorities intervened, but it was already too late: SVB was on the verge of collapse, one that is practically impossible to recover from.
4 Important Lessons To Be Learned From Silicon Valley’s Infamous Bank Run
What can you learn from the collapse of the Silicon Valley Bank, and how can you futureproof yourself as a small business owner or an entrepreneur?
Here are some takeaways shared by Ramon Ray, a small business expert, and an in-demand thought leader:
1. Diversify Your Client Base.
Relying on a small group of clients puts your business at risk if they decide to take their business elsewhere. Having a wide range of clients reduces this risk and makes your income more stable and predictable. With this strategy, you can also move into new markets and reach a larger audience. This can help you grow your business and increase brand awareness.
By having a wide range of customers, you can lessen the effects of seasonal changes or economic downturns that affect certain industries or regions. This ensures that your cash flow remains steady and can help you weather unexpected events.
2. Take a Closer Look at Your Banking Options.
Entrepreneurs and small businesses can become more resilient by reconsidering their banking options. You can’t really say that you’re futureproofing your business if you park money in one place and do not know what the FDIC insurance covers.
The lack of precedent for such an event, where a renowned bank falls victim to a bank run, cannot be the case anymore. Have at least two banking options—preferably a large global bank like Chase and a more enterprising and customer-friendly bank that offers loans with ease.
3. Learn Where Your Bank Invests.
It’s important to know and understand your banking partners’ investment strategies and preferences. It’s a known fact that the funding abilities of startups and small businesses are extremely sensitive to a spike in interest rates.
Futureproof your business by choosing a bank that doesn’t deposit all its deposits in long-dated bonds that will lose value in the event of a potential spike in interest rates.
4. Be Careful How Much You’re Overleveraged.
Over-leveraging means taking on too much debt or relying too heavily on borrowed funds to finance your business. This can put your business at risk if you are unable to make the required payments on your debt.
The more debt you have, the more you’ll have to pay in interest and principal payments, making it challenging for you to future-proof your business. This can eat into your profits and make meeting your other financial obligations harder.
Additionally, too much debt can make it difficult for you to obtain additional credit in the future. This can limit your ability to invest in your business and take advantage of new opportunities.
Also, when you have a lot of debt, you have less freedom to respond to changes in the market or to things that come up out of the blue. This can make it harder to adjust your business strategy as needed.
Takeaway: How To Protect Your Business
The Silicon Valley Bank failure occurred at a time when startups were already facing a tough time at raising funds owing to dipping stock prices and spiking interest rates, causing investors and venture capitalists to retreat.
One of the bank’s specialties was loans known as “venture debt” because they were intertwined with the investments provided by its venture capitalist clients, frequently assisting in filling financial gaps.
Small business owners should be proactive and take action to protect their businesses during a recession. Small businesses can successfully navigate challenging times by carefully managing finances, obtaining financial assistance from government programs or private lenders when needed, and adapting to changing market conditions.
Monitoring cash flow closely to ensure you have enough money to cover your business expenses can also help you futureproof your business and avoid panic in unforeseen circumstances like the collapse of Silicon Valley Bank.