Musing on the Middle Kingdom and More: The Failure of SVB Part 1 of 4

Setting the stage. Also some housekeeping matters.

Dear Friends - I'm excited to be sending out my second newsletter about the Middle Kingdom and more— which in this case, is about the demise of SVB, with no mention of China whatsoever.

But let me start with a bit of housekeeping. As a newcomer to Substack, we goofed in the subscription option for first newsletter we sent out. Rather than having you click a "subscribe" button if you wanted to subscribe, we should have asked you to click the Unsubscribe link at the very bottom of the newsletter if you DON'T want to be subscribed. You were inadvertently subscribed at the start. We're sorry for the confusion and please, if you're aghast at receiving this email, just scroll to the bottom and, right above the "get the app" button, click on the Unsubscribe link, accepting our apologies for the inconvenience as you do. The newsletter is and will always be free.

And now for our next newsletter!

The Avoidable Collapse

Part One

In 1990, I joined what became Silicon Valley Bank (SVB) as a Regional VP and retired almost 30 years later, in 2019, after 10 years as the CEO (stepping down in 2011), four as the President of SVB’s joint venture (JV) in China, and five as the JV’s Vice Chairman. I’m an SVB “Lifer.” I believe in the company, its culture, and its mission of funding innovative companies and venture capital firms. And given my history, I have a unique perspective on how and why the bank imploded in Spring of 2023. In this and three more newsletters, I’ll share it with you. Let’s start with some background.

For forty years, from 1983 until March 10, 2023, SVB was the go-to bank for the best venture capitalists across the U.S. and, more recently, in Europe, Israel, and Asia. It was, in my opinion, both open-minded and appropriately tough. As a result, its market share among venture-backed startups dwarfed all others: It banked well over half of all venture-backed startups in the U.S., and a surprisingly high percentage of those in other innovation centers around the world. In doing so, it contributed significantly to the advancement of innovation in much of the world.

SVB’s approach to underwriting was unique, largely because most of its loans went to innovative start-ups. (The bank did provide banking services to technology companies across the entire range of size and development, but its signature product was “venture debt” loans to young, high-tech companies.) It may seem crazy to lend money to risky, young companies that certainly had no profits and often had no revenues. Venture debt, though, plays an important role in helping startups reach a milestone of development that boosts their value for their next investment round. Rather than the traditional approach of relying on the borrower’s income and assets, SVB’s venture debt loans were based on the quality of the venture backers and the company’s management team, along with the likely trajectory of the company’s technology. If the company failed, we wanted the technology to be far enough along that it could be sold to repay the loan and then used by someone else. Notwithstanding the perceived riskiness of early-stage technology companies, SVB had relatively few losses over the years—and because the bank received warrants (the option to buy stock at a set, low price in the future), its successes outweighed the failures. I retired from my position as Vice Chairman of our Chinese JV bank in 2019 just as the venture capital market reached a pinnacle of activity and profits. I imagined things were set for a long time.

On Wednesday, March 8 of 2023, I learned that SVB, my pride and joy, had pre-announced a significant loss. The loss was engendered by the sale of long-term bonds that were “under-water,” meaning that their rates were significantly below market levels, causing their market value to sink. I was shocked. I couldn’t imagine how this situation had occurred. For a bank to have to sell bonds at such a loss meant that someone in management had been asleep at the switch and flunked Banking 101. Liabilities and assets were out of balance. Yet SVB was one of the larger and most successful banks in the United States. I was stunned and confused.

Later that same day, I learned that several venture capitalists were encouraging their portfolio companies to withdraw their deposits from SVB—even though these same companies would turn to SVB for loans when times were tough. But times hadn’t been tough in the venture world for a while.

By the time I turned in for the night on Thursday, it was apparent that a full-fledged “run” was underway. And when I woke up on Friday morning, it was clear that the regulators were gearing up to take over the bank. SVB would be no more. It was the second largest bank failure in U.S. history, the first having been Washington Mutual in 2008.

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