New Fiduciary Standards and Actions in the Wake of the SVB Failure

The Takeaway: As a matter of practical and fiduciary responsibility going forward, every startup should have: accounts with at least two banks; at least two months of payroll in each account; each account preemptively connected to each payment processor (such as payroll and credit cards). Moreover, most of a startup's funds should be further diversified across multiple money market funds at entities independent of banks.

In less than 48 hours, the bedrock bank of Silicon Valley, SVB, failed.

This failure, both the fact that it occurred and how it occurred, either exposed or created new lessons, indeed, new fiduciary duties for executives and boards of technology companies and beyond.

To be clear, this matter is still unfolding, with more details leading up to it and consequences following from it, to be discovered. But one of the lessons — indeed possibly the most sobering lesson of all — is the utter necessity or burden for us to act immediately, and hence, this article is being published to promulgate what this author sees as being the most insights and actions for executives and boards, discovered as of the time of its publication.

Editorially, at this immediate point of publication, updates or additions to this article are likely as new information is gleaned. Indeed, the author encourages readers to provide further insights or learnings either by emailing the author directly (to neil@motusventures.com) or adding comments.

And of course, in view of our litigious country, it must also be recognized that this article is not legal advice and anyone should seek and use their own legal and other counsel on this matter.

The Salient Fact

The salient fact that has come from this essentially-overnight failure of a 40-year respected banking institution is how any bank is dependent — decisively dependent — on sentiment.

In the opinion of The New York Times columninst Kevin Rose: “But what brought S.V.B. down wasn’t lending to risky start-ups, or gambling on sketchy crypto coins, or some other ill-considered tech scheme. It was an old-fashioned bank run, set off back in 2021 by a series of old-fashioned bad decisions.

At most normal, midsize regional banks, what happened at S.V.B. probably wouldn’t have led to a panic. Banks sell assets all the time. They run into liquidity problems and raise short-term capital to solve them. Most of the time, customers never notice or care.

But S.V.B.’s depositors are not normal customers… Slack channels and Twitter feeds lit up with dire warnings from venture capitalists and soon many people were panicking.”
The New York Times. Kevin Roose. March 11, 2023.

People can, and likely will, debate for years whether or not the failure of SVB was necessary. And therein lies the key wake-up call because there are two specific circumstances about this failure that lead to one particular enlightenment — namely, that we as executives and board members need to view, act and supervise the custodian of a company’s treasury in an entirely new and highly-resilient and high-risk-diversifying way. Sentiment is a capricious and potent behavior that we have all just been shown can happen to almost any Bank and when it happens, has immediate and extreme consequences.

In this saga, two circumstances either one of which was likely just the ups and downs of business, but together, unleashed a turn of sentiment that in turn, drove a forty-year institution into failure and did so in just hours.

Circumstance 1: Rapidly Rising Interest Rates. Banks of all shapes and sizes dutifully placed sizable portions of their deposits into the U.S. government debt and other low-risk securities.

Of particular note, is that what the banks did actually appears good — that is, the full value of customers’ deposits would be available at maturity. So normally, this behaviour is to be admired.

However, the past year, in particular, was not normal. Instead, after 14 boring years of stagnation, interest rates rapidly rose to rates not seen in almost two decades.

This rapid rise in interest rates gave these seemingly prudent bond holdings into paper losses. That is, paper loss in the sense the value of these bonds at maturity remained unchanged (and in particular covered the deposits behind them), even though the market value today was less than the maturity value.

As long as it was “business as usual” everything would work out. But especially in the case of Technology-industry-centered SVB, business this past year was not “usual”.

Circumstance 2: The Downturn in the Technology Industry.

Essentially coincident with the uptick in interest rates, the flush of cash flowing into new and existing startups markedly turned down and established technology companies throttled operations. In practical terms, SVB found itself without the sizable cash flow that it enjoyed from just the comings and goings of large amounts of capital. Even worse, startups were increasingly drawing more cash as new infusions of equity cash were either taking longer, smaller or not happening at all.

And the combination of a portfolio bond with a loss, if sold at market value, with the turn of its clients from depositing to withdrawing cash, was the perfect storm either for SVB to ultimately fail, or at least for people to fear that it would ultimately fail.

Indeed, on Thursday SVB was in the midst of a deal that would have infused it with $2 billion of cash to cover its cash needs through this predicament, but the run on the bank the same day because of this same predicament, reportedly debased this deal from going through, assuring the self-fulfilling outcome of failure.

In the aftermath of SVB’s failure:

• A company’s capital is being constrained to various degrees for some time, and worse, possibly lose some part of it outright (see: Wall Street Firsm Pounces on SVB Implosion With Offer to Buy Deposit Claims. The Information. March 11, 2023, 12:19 pm PST). Right now, companies have no access to their capital at SVB. On Friday the FDIC took over SVB and created a new bank called DINB of Santa Clara. On Monday, companies are supposed to have access via the FDIC up to the limit of $250,000 of insured deposits. Anything beyond that is in some unfolding state of limbo. Hopefully, things will work out quickly, but again, this unimaginable act smacks us with protecting ourselves from such exposure in the future.

Subsequent event: At 6:15 pm EDT Sunday, March 12, the US Treasury, Federal Reserve and FDIC announced a “resolution of Silicon Valley Bank, Santa Clara, California, in a manner that fully protects all depositors. Depositors will have access to all of their money starting Monday, March 13. No losses associated with the resolution of Silicon Valley Bank will be borne by the taxpayer.”

• In parallel, this failure also exposed the dependence and vulnerability of the interconnected operational payment mechanism that hitherto was in the backwater. For example, within hours, startup-oriented credit card services such as Brex were sending out emails to startups telling them to provide a new source of funds or risk having credit cards turned off… which in turn affects a startup’s operational online services such as AWS, Github and Slack. Etsy reportedly stopped paying providers due to its dependence on SVB for processing payments (see: Etsy warns sellers of delay in processing payments due to Silicon Valley Bank collapse. NBC News. March 11, 2023, 9:30 am PST, updated 2:30 pm PST).

Actions/Practices for Executives and Boards to Embrace Now

With these and other lessons in mind, here is a rolling list of actions or practices for startup executives and boards to embrace going forward and even if SVB’s failure is resolved without loss to its customers.

1. Have two or more banks and take specific actions with them.
   The practical reality is that each bank account entails a significant amount of administrative burden and even confusion. This practical fact combined with all the protections and practices put in place since 1929 fostered a reasonable belief and standard that a relationship with a single bank was sufficient.
   No more. In the face of SVB’s failure, this belief, standard and reliance on a single bank are not only questionable, but one could reasonably expect that legally it will be found to failure of a board and officer’s fiduciary duties to employees, creditors, the company and shareholders.
   Moreover, there are specific actions to do with these banks. Notably: (i) have deposits covering two months of payroll in each bank, and (ii) have both banks connected with each payment provider such as Gusto and Ramp.
   These two particular actions come from the lessons made explicit by the aftermath of SVB’s failure.
   Especially in California, employees need to be paid. And they need to be paid on time. Failing to make payroll is a violation of wage and hour laws. But that is just the beginning. It starts with penalties but can lead to liabilities for individual officers, directors and any other decision-makers. Requiring employees to work when you know that you can’t make payroll exposes officers and directors even more. Indeed, even presently, companies may need to literally layoff employees while they sort through being able to pay them rather than keeping them employed knowing that you can’t pay them in accordance with employment laws. Citing the fact that the second-largest bank failure just occurred may cut you some slack, but now that exposure to a single bank failure likely no longer qualifies as a force majeure, we as officers or directors need to install practices and systems that transcend another SVB event.
   Taking the above actions solves all of this. That is, having two banks, each with sufficient capital for two months of payroll, and preemptively connected to payroll and other payment processing services likely shows sufficient fiduciary duty and similarly, will all but certainly avoid the mad scramble, rushed board meetings, and other “Clean up on Aisle 5” going on throughout Silicon Valley across hundreds of startups literally as this article is being prepared.

There’s also another advantage of having two banks. Namely, as one of my startups enjoyed, it gave them the ability to immediately wire out funds from a failing bank to a healthy bank. This startup didn’t have two different banks in anticipation of such an event, but the fact that it both had two banks and both banks had wiring templates set up to immediately wire funds from one to the other, likely made it possible for this startup to now be in the relatively comfortable position to cover its payroll for two months while the mess with SVB gets sorted out.

Delta of Bond Value. There are many factors that affect the solvency of a bank, but the rapidly rising interest rates have made the difference between the market value and held-to-maturity value of a bank’s bond holdings. Notably, The Wall Street Journal specifically highlighted SVB’s loss or delta of -$15.9 in November (see: Rising Interest Rates Hits Banks’ Bond Holdings. The Wall Street Journal. November 11, 2022). The adverse impact of rising interest rates on Banks affects even the big ones — for example, the Journal article identified that Bank of America had the largest book loss (-$116 billion) of all of the Banks.

2. Third-Party Money Market Funds. One bright spot that is emerging from SVB’s failure is that the sizable amount of funds put into SVB’s Deposit Sweep Accounts is likely detached from SVB’s failure. These Sweep Accounts actually hold shares in money market accounts maintained by third parties — SVB is merely an agent. According to Cooley LLP, the underlying agreement of these accounts indicates that in the event of SVB’s failure, the FDIC should recognized the client’s ownership in the Money Market Fund instead of being a creditor to SVB.

If the FDIC agrees with Cooley’s read of the agreement, there will be some delay in distributing the cash back to customers as the Money Market Funds have a limited view into SVB’s actual customers, but the end result will be a return of capital.

But regardless of what happens in this particular matter, the lesson here is to include another dimension of diversification by deploying much of the cash that a startup raises across multiple money market funds. This might be done via a Bank as SVB did, but could be a third party.

Another reason to do this is that one of the interesting if not amusing questions that have been raised by numerous directors and executives since Friday, is “which bank?”. That is, in the face of SVB’s “unimaginable” failure, stated rhetorically shouldn’t one assume that this could happen to almost any other bank? To wit, the answer to this question is to diversify not only across banks but also across non-banks and different instruments as well.

Historically, diligent CFOs have dutifully worked to place a company’s funds in entities where they can maximize returns within prudent (i.e. low) risk predicated on a belief in the durability of banks; now funds must balance returns with a built-in resilience against banks not being durable.

3. Initial Thoughts on Banks. In exploring what bank set-up that combines the startup-smart banking provided by SVB with resilience, a barbell-like structure with one “big” bank and one quality “speciality” bank has come up often. Via email, I can provide contacts to people at some of these banks actively setting up accounts for startups.

Morgan Stanley, Goldman, JP Morgan, Bank of America, and Chase are examples of big banks. Morgan Stanley is probably the best “tech-smart” of the big banks, while Bank of America is notoriously dumbed-down.

In terms of quality speciality banks, two banks in Silicon Valley that have some catering to startups, but have always played second-fiddle to SVB are First Republic Bank and Bridge Bank. Because First Republic Bank is closest in customer profile to SVB, it has come under some questions as to its exposure (see: First Republic, Regional Peers Try to Boost Confidence After SVB. Bloomberg. March 10, 2023, 5:40 pm PST). First Republic subsequently made arrangements through the Federal Reserve Bank and JPMorgan Chase & Co arming it with: “unused liquidity to fund operations is now more than $70 billion” (see First Republic Bank Strengthens and Diversifies Liquidity. First Republic Bank. March 12, 2023, 5:29 pm PST).

Startups with relatively small amounts of capital (e.g. under $10 million) may also want to use CDARS (Certificate of Deposit Account Registry Service) which allows them to invest in Certificates of Deposits (CDs) held by many different FDIC insured banking institutions, thereby achieving full FDIC coverage.

Closing Thoughts

SVB’s failure is a call to action for all of us to help the Tech industry by marshalling and sharing our best ideas and innovations. In particular ideas and innovations that carry the industry through this unprecedented circumstance with minimal adverse impact on employees and companies, and ultimately put in place structures and practices instilling resiliency against the financial ground underneath us moving… much as previous earthquakes have made Silicon Valley that more resilient against earthquakes moving literally the ground underneath us.

Hopefully, this article will contribute to or spur us all toward making this happen.

Below is a rolling list of articles that may be of use to your company, its management team and its board as you navigate this extraordinary circumstance.

Strategic Actions / Q1'23 Mid-Quarter Update. March 8, 2023. SVB.

Startup Bank Had a Startup Bank Run. One problem for Silicon Valley Bank is that its customers had too much cash, and now they don’t. Bloomberg Opinion by Matt Levine. March 10, 2023, 12:34 pm PST, updated March 11, 2023, at 12:21 pm PST.

A note from Ramp’s CEO regarding SVB. Ramp. March 11, 2023, 6:25 pm PST.

Circle’s USDC Stablecoin Breaks Peg With $3.3 Billion Stuck at Silicon Valley Bank. The Wall Street Journal March 11, 2023 7:21 pm ET.

Investors, Startups Work to Find Cash Lifelines After Silicon Valley Bank Collapse. The Wall Street Journal. March 11, 2023, 10:59 pm ET.

Common Questions Regarding Access to Funds After Failure of an FDIC-Insured Bank. Cooley LLP. March 11, 2023.

Where Were the Regulators as SVB Crashed? The Wall Street Journal. March 11, 2023.

McCarthy Says He’s Hopeful for SVB Announcement by US on Sunday. Bloomberg. March 12, 2023, 7:23 am PDT.

Joint Statement by Treasury, Federal Reserve, and FDIC. March 12, 2023, 6:15 pm EDT.

J. Neil Weintraut is a partner are Motus Ventures. Neil can be contacted via neil@motusventures.com