Tech Uncensored - An Altitude Accelerator Podcast

Hessie Jones

Welcome to Tech Uncensored. My name is Hessie Jones and this week we're talking Silicon Valley bank. We're talking about its failure, we're talking about the social media storm that actually permeated the mainstream news cycle and a global banking sector. This actually caused more of an amplified scrutiny in banks as Moody's. I don't know if people realized earlier this week, the US credit rating agency actually downgraded the banking system to negative from what previously was deemed as stable. So we're talking about Svb, which is a 40 year old banking institution, the 16th largest bank in the US. It had $209 billion in assets and they primarily provided their services to the tech industry. So this is the largest bank failure in the US since 2008. This has been a whirlwind and the impacts have been felt here in Canada. So today we're going to discuss what happened, what are the implications to startups and their businesses, as well as the outlook from an economic perspective in the coming months. So is there going to be a silver lining in all of this? I'm pleased to be joined by both Steven Foerster, who is a university professor at Western Ivey Business School, as well as Paul Barter, who is a strategist, as well as an Entrepreneur-in-Residence here at Altitude Accelerator. And also Andrew Apollo, who is our board member as well as general partner of Preference Capital.

Hessie Jones

So, welcome everyone, to this discussion.

Stephen

Good afternoon.

Hessie Jones

So, I'm going to start with Stephen. You are a finance professor, so you know this stuff really well. You wrote recently on your blog about the lessons that we need to learn from SVB's failure prior to the run on the bank. So there are a number of missteps that the company had taken. Did this combination eventually lead to the run on the bank?

Stephen

Well, thanks Hessie for the opportunity to chat with you today. I think we can look at two categories, things that SVB did and is responsible for, and then some things that are beyond their control. Let's start by focusing on SVB. I think it's important to just start with the fundamental, what a bank is and how a bank makes money. The traditional banking model is to take in deposits, pay X percent, and then lend out that money at Y percent. And hopefully Y is greater than X, and that's how they make their money. What was somewhat unique about SVB, as we know, is that it was truly a niche bank focusing on the startup community, which served an important area. But it had a customer base that was not diversified. Eventually we'll see how that led to its downfall, but there were a lot of other factors as well. One was growth. Andrew actually, as a former executive MBA student, knows this well. I often say that growth is good, growth is a good thing. But one has to be careful in terms of how fast one grows. So there are some limits to that.

Stephen

What happened with SVB is between March 2020 and March 2022, its deposits ballooned from $60 billion to $200 billion. So startups, lots of flush with cash. So they had excess money that they didn't need to deploy. So let's put it in SVB. So now SVB has a problem. They have more deposits coming in than loans that they can lend out. So now we're sort of going counter to this traditional banking model that I talked about. And so the other problem was, what do you do in terms of some safe investments that will at least put your money to work in some sense? And at the time, short-term Treasuries were only paying about a quarter percent. So a decision was made to invest in long-term Treasuries that were, at the time yielding, about 1.5%. So this isn't 2008 all over again. These are not risky investments. But here we have the classic mismatch between assets and liabilities. So what do you do in a case like that? Well, the normal thing to do is, well, either you don't take on that mismatch, or if you do, you want to manage it carefully.

Stephen

And so up until mid-2022, SVB did have some risk management hedging techniques in place, but they dramatically cut back on these. And what's also curious is that for most of 2022, the firm was without a Chief Risk Officer. So not a great position for the 16th largest bank in the US. What also SVB didn't consider is moving from this rapid growth stage to just the opposite. This is where the startups needed money. Between March 2022 and December 2022, there were substantial withdrawals. Nothing to do with SVB, just the nature of these startups. And $27 billion in deposits were withdrawn. So now we've got SVB painted in the corner. They're going to need some cash to balance that. So what are they going to have to do? Well, they're going to have to sell some of their investments, these long-term Treasuries. The other thing that is sort of as fundamental as a law of physics is that when interest rates go up, bond prices go down. And so we had an environment where interest rates were going up dramatically. And so there was a loss on selling $21 billion of these long-term Treasuries, and the loss was $1.8 billion.

Stephen

Still not substantial, but it spooked the markets because at the time SVB announced that they had a plan to raise $2.25 billion in capital. Well, having a plan without executing on it, that's really what spooked depositors. And unlike the classic bank run that you might have seen in it's wonderful life, and in other places, this one was all just some simple texting on a phone and poof, SVB was no longer. So a lot of things that they could have done differently. Very briefly, external factors. We had some regulatory rollback, dot Frank's, which was set up in 2011 to really keep a close eye on financial institutions. The initial notion was that any financial institution in the US that had more than $50 billion in assets would face increased scrutiny, have to put aside more capital, and so on. But in 2018, that was loosened up and the threshold was increased from 50 billion to 250 billion. So SVB and others of its similar size were no longer under this regulatory microscope. The final external factor that I alluded to before is the unintended consequence of the tightening of the Fed and increase in interest rates.

Stephen

And this is a consequence.

Hessie Jones

Perfect. Thank you so much for that background. I know there are a lot of moving parts from that perspective, and we can't say that Peter Thiel is the only one to blame for this mishap. Okay, I'm going to turn to Andrew, because now we know that the US government is going to protect depositors over and above that 250,000 threshold. So it's not only for SVB, but they opened up lending windows to some of the banks that were also impacted by it. So startups on the whole are kind of breathing a sigh of relief if they've had deposits. But for the most part, if you were an investor in SVB, you lost. So what is the broader impact on the investor community, especially as we know that a lot of some major, let's say VCs, even large startup companies, as well as accelerators, had put their money and assets into SVB. What is this influence within the VC sector as you see it?

Andrew

Well, in general, being from the startup side and being the guys that were pitching these powerpoints and these keynotes and stuff to these investors in California, SVB was the one place that was kind of like the single source of truth in terms of your value. Like, if they liked something, that was a stamp of approval. Right? So we as companies went to them because they had a whole network. They had the investors, they ran funds, they ran their own specialized fund. They had like a securities division. They had a bunch of things where they had just the best Rolodex for " hey, I saw some interesting ideas and these people are getting traction. Would you like to meet them?" kind of introductions, which are gold. These are the best things you can have. That marketplace existed before SVB was around. It existed in smaller pieces. So SV Angel, Sequoia, Anderson Horowitz, they all did their part to make a system like this, where there'd be lots of meetings, like Y Combinator has. Y Combinator is probably the most active kind of dating service in San Francisco, and they actually just let go 10%, I think, of the people on staff too.

Andrew

So this has to exist. There's no way for startups to continue in a haphazard way of contacting people on LinkedIn or trying to find people on Twitter. So this has to exist. Number one, there'll be a hole here. If this doesn't continue SVB, somebody will fill it. Somebody will fill it with either the same investors or will put $0.10 on the dollar they lost, and they'll say, we're going to start SVB again. We're going to hire the staff, or we'll buy the assets, or whatever it is. It has to exist. What SVB did and the way it got into every meeting, and the way that the brand they developed the brand, and the way they defended sort of the risk appetite of entrepreneurs hasn't gone away. As Stephen underlined, it was kind of like they made some large functional mistakes. But the actual underlying premise of why they existed didn't change. And it still has value. I think, in general, I don't know what's going to happen. We were waiting for Monday's announcement that J. P. Morgan was going to buy them. That's what we were waiting for.

Andrew

And then we found out later that the CEO was told by his board, do not take any calls from the Treasury Department. Like, do not take any calls this weekend. Because they weren't happy with Washington Mutual and Bear Stearns. I think the government may continue to manage this and leave it hands free and let the operations team move it forward and keep to the style of what they've had before. Obviously, they have to do some cuts and changes like everybody's doing right now, but it's a need. Because it's a need and you have this ready-made, kind of rooted sort of answer to that need, it does add a lot of value for a sale for SVB.

Andrew

Just a quick story. So we're putting up our payments on Thursday. We don't work with SVB. We have branches all over the world, and SVB is a very US bank, so we have difficulty with their transactions. But we were setting up some payments on Thursday to SVB contractors that we have, or SVB people that banked at SVB and the transits were not going through.

Andrew

And so we just left it for Friday. But then when we saw the news on Friday that the bank was sort of closed, we were like, "well, what do we do?"

Andrew

So we contacted them over email and we sent them PayPal at an incredible rate on our side, but we don't like not paying people, so we did it the best we could. We have investments in a number of companies. My network has probably but 31 active investments right now. And so we have a little bit of an email newsletter and we quickly just copied everybody "hey, what's going on?"

Andrew

We got somering rings from Investees. We had Julia, who's the CFO of a company in Sacramento. She said that they were in a full panic mode the whole weekend. Then people started looking at the FDC announcements and things like that and they realized that actually, if the government is going to keep to what they're saying, nothing will happen. It's going to be fine. And she mentioned it on Monday. She goes, when she saw all the accounts there on Monday, she was locked out of them when she logged in.

Andrew

But there was a link on the web page that she could click on and they helped her get everything unlocked. She immediately was like, 'I was thinking that our company was dead on Friday and everything is fine.' She kind of said she feels like a child for believing that terrible story during the week and she hopes it never changes from this. Then our group starts looking at who's going to buy them, right? So who's going to take the pieces or take the whole thing? Because that will affect the story. This SVB-type entrepreneur support network, if it's broken up, we have a sense that it's going to turn to a regular bank for the people putting money in. Then you get this thing where now it doesn't matter that you're in this bank because you're trying to get to the Capital Group or you're trying to get to the LP Group, right? So if you're in the bank and you have a good record and you're showing you some transactions and stuff, you can get into these VC groups through the bank. Where now if you put that into a regular bank like JP Morgan, there's no reason to bank there.

Andrew

Why would you bank? I mean, there's really no difference in these accounts. So we as a group are looking at if this exists going forward in a longer-term fashion under government management, it may be the safest bank in America right now, for entrepreneurs anyway.

Hessie Jones

Okay, so let's take a little bit of that, especially from the impacts on the US side. Now let's look at home because we're starting to see ripple effects here. I want to turn to Paul for your perspectives, because there was recently this week a group of Canadian tech community people, I think they represented VC as well as private equity. They actually had an open letter to the Canadian government saying that the failure of SVB, and I quote, "the resulting collapse in investor confidence has created a crisis in liquidity for Canada's tech sector and well beyond SVB at precisely a time when we are extremely vulnerable."

Hessie Jones

So they wanted to argue that there is a systemic risk when a lot of people have said it's not. That we cannot rely on the FDIC to ensure liquidity of the Canadian innovation economy. So partly like from what Andrew talked about the impacts on some of the US startups. The Canadian startups that have had accounts with SVB are saying that FDIC is not in a hurry to wire up money to Canada. So it goes beyond the deposits and also being able to actually cover many of their operations and expenses.

Hessie Jones

This is now an impact that I would say has psychological effects on startups to do business. Is their bank safe? Is there a better place to put my money? Am I able to raise? How do you respond to that local impact from a startup perspective?

Paul

I think there's several questions there. I would say that the quote that you just gave access to capital in the innovation economy in Canada, probably not much has changed in the last week. So we were competitively disadvantaged versus the US. certainly versus the Valley. From the perspective of access to risk capital in Canada, we're safer up here in our banks generally. And one of the reasons we're safer is we don't invest quite as much in risky new bets. I think we're still pretty safe up here. I wouldn't be too concerned about the safety of assets for companies that have raised already. But I am concerned from a forward looking perspective about access to capital in Canada and in the US and around the world if Silicon Valley Bank doesn't come out of this as roughly a similar player to what they are today. My general perspective is lots of people talk about innovation, but innovation is risky, right? There's a reason that the lion's share of the investments that venture capital funds make fail, right? So venture capital funds make their money on that small number, that one in ten or whatever small number of players that blow the markets away.

Paul

And also Canada is a little bit behind the US. We're a little bit of a follower relative to making risky new bets on 'over-the-horizon' new crazy technologies, right? Because a lot of those technologies are crazy until the day they take off. When you get something like probably everybody on the call now has heard about chat GPT, when you go from technology that only the geeks are talking about to a technology that a million people are using a week later, to a technology that 100 million people are using a month later, it's not a crazy, 'over-the-horizon' technology anymore.

Paul

Speaking of technologies, that's my watch weighing in on the conversation. So I think it's mitigated some of the issues or maybe kind of multiplied some of the issues that we had already here. I mean, we have been in a tech downturn. We saw the financial markets really hammer tech last year as we emerged from COVID. Many companies, big and small, saw the value of their equities plummet and that trickled down, right? So if the big companies see their stocks go down, then the likelihood of investors investing in risky high multiple startups goes down as well. Right?

Paul

So it's been a tough time and there's definitely, both because of SVB and because of things that happened before, it's definitely a more difficult time to raise funds in Canada and around the world right now. I think there's some mitigating things and I'll speak to that perhaps later.

Hessie Jones

Okay, so I'm going to turn this to Steven because based on what Paul has said, we have tons of innovation in Canada. And some of the reasons why a lot of startups go to the US for support for funding is because of the fact that we have a very risk-averse environment in Canada. When we're talking about innovation we need to be able to keep our startups here in Canada. We need to be able to support them in many ways. SVB, there isn't a bank like that in Canada and they're not necessarily as friendly to startups because our overall, I guess, conservatism in Canada is much more heightened than it is in the US. So what do you say about the events in the last week and what that means in terms of Canada?

Hessie Jones

Thanks, Paul. And is it, siri? Siri.

Hessie Jones

What should banks be doing differently? At least the Canadian banking system?

Stephen

Yes, so I think those are great points and I think absolutely the Canadian banks need to step up their game rather than have the majority of Canadian tech companies relying on some kind of US form of funding. So I think there's an opportunity for Canadian banks. But I want to go back to what Andrew said because I think there's a big caveat as well. It is that it's not as simple as Canadian banks saying, "Okay, well, we'll provide line of credit, or whatever it might be."

Stephen

It's trying to recreate this magic of SVB that took four decades for them to create and to be more than just a lender, but to provide networking opportunities and the Rolodex and all of these things. So that's going to be a tough model for any Canadian bank to try to replicate.

Hessie Jones

Thank you. Does anybody have any other comments on that and whether or not we could improve it?

Andrew

The conservative we're looking at us versus the US. US is probably the biggest shoot from the hip, western style, invest in anything, cut the deck from I'll play from other side kind of group. They are happy to risk it on people, right? We are comparing ourselves to them and we are terrible and we're touching our chest. It's our fault and everything and everything is terrible. But we are probably number two in the world in risk appetite. So I would not be so down that's like, European markets are incredibly difficult. Like Nigerian Markets, Indian Markets. We have so many people coming here to get a visa, a startup visa, and get investment here because they cannot do things there without owning a home or having a rich relative that can finance something. We have a good appetite for risk. It's not as good as obviously the US is. I think we can work on a few things in that case. BDC has been turned into a better bank because SVB has been working in our space. They've added balloon payments, they've added no interest hold offs on payments. They've added the two to 12% additional risk rate for how crappy your business is.

Andrew

I mean, they've added a lot of things that they only added because SVB was competing for their business. So if they could manage and SVB is a very conservative lending organization. There's other smaller groups like Lending Loop. There's Clearbank. HSBC has an e-branch kind of thing for startups. People are moving into the space and maybe if they get the urge, they'll take on a little bit of risk and they'll improve Canadian risk appetite. We also have a very strong and almost detrimental securities group in Ontario that will not let anything happen because it's not say you're not an accredited investor or like you don't have a financial degree or something.

Andrew

This limits also our abilities. In the US they have wide-open crowdfunding. Anybody can invest in anything, almost. You as an investee, as a company, have to do some due diligence and protect the people investing and give them all the information they need. But in Canada we still have, I would say, some of the leftovers of all the other failures that we had in the UK and in Europe and the South Sea bubble. There's still some sort of genetic memory of these things and we're being cautious, right?

Andrew

So I don't want to dump entirely on us. But it's true, compared to the US. We're not that good. So there are some things we could probably add, and Steven spoke a little bit at the beginning about some class comments. Risk is rotten, growth is good, and everything's about the future. And I think there are many times when growth is not necessarily linked to more risk, and that very often more risk is sometimes not linked to growth. And I think if we can find a lending market, it could probably, with enough information, find good risks that are growthful for us and we can improve there. I think it just needs some dedicated minds and I think we'll improve in this case, but not to the level of the US for sure.

Hessie Jones

Okay, thank you. So I'll turn to Paul because not to divert from the events of this week, but maybe yes, to divert from the events of this week. There is a silver lining in what has happened. What should startups start to look towards? What can they bank on these days, given the circumstances?

Paul

Yeah, so startups are risky by definition, right? It's different than going and getting a job at a bank or for the government, or getting a pension and settling in, right? You're kind of like a bond if you do that. Startups are like stocks, right? They're riskier from that perspective and that's part of the wave. But innovation goes in waves. And in fact, I think McKinsey talks about their three horizons. They talk about the current horizon, technologies that are kind of at their peak and, companies that do innovation against those technologies. But perhaps that's beginning to decline.

Paul

The second horizon is technologies and markets that are kind of on the rise and are going to be kind of the next big thing. The third horizon is things that are still a little bit farther out but maybe in a decade might come to fruition, right? You know, tech is a whole bunch of things, right? We use that term as kind of a fine definition. But some of my mentors like the idea of science-based innovation. We define tech more specifically as information and communication technologies.

Paul

The Internet wave is 22, 23, 24 years old now, right? And that's permeated through the economy. And we've seen the rise of the biggest companies in the world, most of which were formed in the last, dot com bubble crash or in the global economic downturn. Those are the trillion-dollar companies that are out there today, right? But there are those net waves.

Paul

So I was saying before the call that when we look back at this week in a decade or 20 years and ask ourselves what's the biggest thing that happened this week, it's probably not going to be the crash of Silicon Valley bank. It's going to be the rise of machine learning. There's been literally a dozen new announcements this week of companies that have brought to market multi-hundred-billion-dollar type opportunities. There's a ton of capital that's been raised by companies. There's probably no one on the call now that hasn't played with chatGPT. Their next generation just hit market. Google launched some things, facebook launched some things, a bunch of newly funded companies launched some things. That's going to be the next 20-year wave, just like the internet was. We're going to see that permeate the economy.

Paul

And then beyond that there are things that are going to come in this third horizon that are going to target healthcare and some other areas. So there's lots of other opportunities. In the short term, cash is king. So if you've got cash, as I'm sure Steve would tell you, marshal it, use it effectively. Those that have cash are going to go out and look at the assets of those that don't have cash now. So it's an interesting time to go looking for resources or intellectual property or capabilities that you don't have in-house. Also employment, right? There's a lot of people that are on the street, solid tech workers that are on the street. Not so much because of Silicon Valley Bank, but because of things that have happened in the previous year. If you really want to hire great developers, they're not going to cost what they cost, the outlandish costs that they would have been in the middle of 2021. So there's people available, there's new trends that are going to create the next trillion-dollar companies. Are we at a bottom? I don't know, but we're near a bottom.

Paul

The companies that accelerate out of this downturn are going to be the ones that we're all going to be getting together in 20 years and saying, 'I wish I'd invested in them.'

Hessie Jones

Thank you for that. Okay, Steven, I'm going to turn to you. We have a couple of minutes left, so I want to address this to you as well as to Andrew. From a financial standpoint, what lessons should startups actually take away from this to better control their assets and mitigate their own financial risk?

Stephen

I would say two things. There's that old saying that the best time to get a bank loan is when you don't need one. So I think for startups, be prepared for that rainy day access capital when you can, including getting a line of credit. The other thing I think is that pay attention to cash management. I don't think that was on a lot of startups' radar. The incredible thing that came out, the news story to me was that this publicly traded company, Roku Incorporated, that makes streaming devices, had over $487 million in uninsured money at SVB. So cash management, pay attention to it.

Hessie Jones

Thank you so much. Andrew, I'm going to give you the last word. What's your advice as a VC as well as a startup guy?

Andrew

So find your friends. We were planning to extend some loans to some of our investees, but it turns out it was not necessary. Find friends, don't spend. As everyone's been saying, there is money everywhere. Link yourself to a growing market, as Paul mentioned, and you'll convince somebody of your value. So I think there's hope. It's going to be hard work, like always. And don't read the winners that are in Tech Crunch because those are just outliers. It's hard work and you got to do it, but you can do it. So good luck.

Hessie Jones

Perfect. Thank you so much. So I think that's it for today and I want to thank my guests for joining me to break down a lot of the harrowing events that actually happened in the last week. If you in our audience have any questions or concerns about SVB, what it means for your business, we are opening up our channel. You can email us at communications@altitudeaccelerator.ca and we'll schedule some time to meet with you through our advisors as well as our EIRs. So please send us your comments or emails.

Hessie Jones

That's it for this week for Tech Uncensored. By the way, we are on podcast. So anywhere you could get your podcast, you will find us. My name is Hessey Jones. Until next week, have fun and stay safe.

Stephen

Thank you.

Hessie Jones

Thank you.