Mar 17, 2023 9:00 AM
The Ugly Lessons of Silicon Valley Bank’s Collapse
At first glance, the Silicon Valley Bank debacle seems to be a cut-and-dried financial caper. The executives running the 16th-largest bank in the US made the wrong choices in handling what seemed a fortuitous situation—a roster of clients, flush with venture capital funding, handing over billions of dollars of cash for storage in the institution's coffers. But the bank’s leaders misjudged the risks of higher interest rates and inflation. Pair that with a mini tech downturn, and the bank’s spreadsheets began turning colors. When word of its perilous situation got out, panicky depositors pulled their money. After a government takeover, everyone’s money was safe.
But although no depositor lost money, the saga looks like a traumatic event whose consequences will linger for months, or even years. Things happened that we can’t unsee. The SVB saga reminds me of what my wife, a true-crime reporter, says when people ask why she finds murder stories so interesting. A killing, she’d say, reveals the previously private, shrouded actions that define the way people live. In the course of investigating the crime, lives that looked ideal from the outside are exposed as unmade beds of secrets and lies.
Start with the bank. As has been widely reported—only now with a critical eye—Silicon Valley Bank was not only the bank of choice among Silicon Valley companies, but an ingratiating cheerleader for startup culture. The VCs and angels funding new companies would routinely send entrepreneurs to the bank, which often handled both company accounts and the personal finances of founders and executives. SVB would party with tech people—and vintners, another sector they were deep into. Some bankers had wine fridges in their offices. Salud!
Normally, you’d have to hold my family hostage before I became a banker—I picture the buttoned-up prig who hired Mary Poppins. But I might think differently if banking were a world of parties, high-end Cabernets, and elbow-rubbing with universe-denting geniuses who keep millions in the bank and take out mega-mortgages. By all accounts, SBV shared and perhaps amplified the freewheeling vibe of the swashbucklers it served. This is not what you necessarily want from a fiduciary. And as we learned this week, SVB’s CEO reportedly indulged in one of the worst things a founder can do—selling off stock when trouble lies ahead.
When that trouble arrived, we also learned a lot about the investment lords of the Valley who give founders the millions they need to move fast and make things. As word began to leak of SVB’s weaknesses, VCs who style themselves as tech’s smartest people had a choice: help bolster the financial partner holding the industry’s assets or pull funds immediately. The latter course would trigger a panic that would assure disaster for the startup ecosystem—but not you, because you were first in line.
Despite years of talk about how companies in the tech world are united in a beneficial joint mission, some of the biggest players went into self-preservation mode, essentially firing the starting pistol for a bank run. One notable bailout leader was Peter Thiel’s Founders Fund, which got an early sense of SVB’s troubles and advised all its companies to get out ASAP. As word spread, a classic bank run took shape, with other VC firms urging pullouts, until it was impossible to connect online with SVB to move funds. By the time a group of VCs came together to pledge support for SVB, its virtual doors were shut. In the mad rush to the lifeboats, hundreds of companies were stranded on deck. When the Federal Deposit Insurance Corporation (FDIC) took over Silicon Valley Bank last Friday, with all activity frozen, those whose holdings in the bank far exceeded the $250,000 limit on insured accounts truly faced the abyss.
I get it—saving one’s own skin is human nature. But in the future, let’s go easy on hyping the camaraderie of tech.
And what did the Valley’s rugged individuals do when oblivion loomed? They begged for a government rescue, of course. It’s hard not to empathize with some of the rank and file tech workers, many of them far from California, who wouldn’t be able to meet their bills. And indeed, there were some acts of generosity, as investors extended loans to their portfolio companies. But the loudest voices urging bailouts didn’t seem to be those most in jeopardy, but super-rich investors and speculators likeself-described angel investor Jason Calacanis, PayPal mafia billionaire David Sacks, and Machiavellian hedge fund magnate Bill Ackman, bombing Twitter with over-the-top pleas to rescue depositors.
Their case was that if depositors didn’t have immediate access to their funds, SVB’s woes might be “contagious,” setting off a wider bank panic. A reasonable concern. But it’s unlikely these pundits would have made the same arguments if the institution in question were some regional bank of similar size in the Midwest. Some people arguing for a federal bailout had previously opined that the government should keep its tentacles away from the innovative geniuses of the Valley.
The spectacle is particularly ironic because a huge part of startup lore is not just accepting risk but embracing it. We hear endlessly of the bravery of entrepreneurs who step into the breach and put millions of dollars in jeopardy, hoping to buck the dismal odds of creating a difference-making company that, by the way, makes its founders ludicrously wealthy. It’s part of the game to lose your investor’s money and a couple of years of your life because you felt that a $400 juice machine would be the next iPhone.
Now those noble risk-takers were demanding retroactive protection—because tech-company money was unavailable due to a totally avoidable risk. Any idiot knows that FDIC covers only $250,000. So why did so many firms store all their assets in uninsured accounts in a single bank? You might give a pass to naive founders who blindly accepted the recommendation of their funders to use Silicon Valley Bank. (Though maybe not to big companies like Roku, which had $487 million on deposit in SVB.) But what’s the excuse of those who did the recommending? Did they notice that SBV executives actively lobbied to avoid stringent regulation? Or that for eight months, SVB failed to replace its retired chief risk officer? Did they understand that an entire startup monoculture patronizing one bank made a huge industry dependent on a single point of failure?
Meanwhile, less verbose investors and VCs quietly worked behind the scenes on convincing the FDIC to guarantee all deposits. One of the Valley’s top seed investors, Ron Conway, reportedly even got Vice President Kamala Harris on the phone to hear his plea for a depositor bailout. The case they made for protecting funds from a maximum $250,000 to, well, infinity, was a more refined version of what the Twitter panics-spreaders were saying: It would stem a collapse in the tech sector and calm people all over the country who were suddenly worried about their own banks’ stability. (It would also mean that from this point forward, holding to the limit is indefensible.) It’s not clear whether the lobbying affected the actual decision. But the attempts were unseemly, an unattractive display of the power of this massive industry.
So what has been uncovered in the week since we learned that Silicon Valley Bank was no more trustworthy than a crypto spam text? A startup culture once considered the gem of the economy has been exposed as careless with its money, clueless in its judgment of character, hypocritical in its ideology, and ruthless in exercising its political clout as a powerful special interest. Meanwhile, the financial world is still jittery, with other banks failing and just about everyone wondering what comes next. And from here on, the concept of a cap on FDIC insurance is at risk. But at least the SBV credit cards are working again. And VCs can take a victory lap as they brag about how they saved the day.
Things were so much simpler in 2007. I wrote about the then nascent Y Combinator startup incubator, and even sat in when investor Mike Maples first met with the founders of Weebly, a DIY website company. Since I wrote the story, Y Combinator has invested in over 4,000 startups, with a combined valuation of over $600 billion. Its initial investment in each company has skyrocketed from under $20,000 to half a million bucks. And Maples, then early in his investment career, has become one of the Valley’s top seed funders. His super-early stake in Weebly, for instance, paid off well—in 2018, Square bought the company for $385 million. It’s not clear whether the Weeblies deposited their winnings into a Silicon Valley Bank account.
Y Combinator’s model dovetails perfectly with the new startup ethic in Silicon Valley. It’s dramatically cheaper to start a company now than it was in the dot-com boom, and possible to build a substantial operation before requiring venture capital or achieving that liquidity event. (To pay salaries and costs during that time, one can get “angel funding”—less money than a VC firm pays, but in exchange for less equity.) Software tools, which used to cost hundreds of thousands, are now largely free. A wide variety of tasks can be outsourced cheaply. Computers, servers, bandwidth, and storage cost a fraction of what they did a decade ago. And there’s no need for a marketing budget when you’ve got internet word of mouth.
As a result, when it comes to funding, “$500,000 is the new $5 million,” says tech investor Mike Maples. It’s several weeks into the program, and Maples is in a Palo Alto, California, coffeehouse for a meeting with the Weeblies. He sees a lot of people barely out of their teens. The old wisdom for investors in startups said you needed an experienced hand as a CEO. The Valley’s new wisdom: Don’t fund anyone over 30. The average age of Y Combinator founders is 25.
When the Weeblies show up for the meeting, they pull up Maples’ website and, using their software, clone it almost instantly. Then they show him how he can use Weebly to tweak it easily and even redesign it. Maples’s eyes open wide. Later he will explain that at that moment, he was determined to help fund the Weebly team.
Chris asks, “What lesson would you prioritize in teaching children about generative AI?”
Thanks for the question, Chris. This is a hard one, because generative AI—software that’s trained on huge amounts of information and can generate content instantly in response to text prompts—is in its first stages. The kids confronting it today will be using hugely more powerful versions when they reach adulthood. I suspect that by then they will be generative-AI-native, just like previous generations were the first to claim themselves as PC-native or social-media-native. Eventually those gen-AI kids will be teaching us how to handle it.
For now, I would encourage kids to play with the generative AI chatbots and other tools in use now, and those soon to be released. It’s a great way to satisfy curiosity about various subjects. But I would emphasize that not all the information chatbots provide is accurate, and some of it is crazy wrong. I would urge them to regard the responses as pointers to primary sources, online and off. Like … books. Of course, I’d tell them not to use AI outputs to replace homework. You might fool your teachers, but you won’t learn anything.
But most of all, I’d drill it into their heads that while a chatbot might come off like a person, it’s not human. It’s a tool, and even if it calls you by your name and responds in a friendly way, it’s not your friend. And then I’d take them to the library to find a good book.
You can submit questions firstname.lastname@example.org. Write ASK LEVY in the subject line.
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A deeper dive into the culture of Silicon Valley Bank.
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