Crisis and Opportunity

Margin Call versus The Big Fix

People are analyzing Silicon Valley Bank’s failure as a simple mismatching of cash flows and obligations. Silicon Valley Bank had long-term debt paying low fixed rates, and as their funding cost rose, they were losing money. Then, when companies needed additional liquidity, they had to sell those assets at a loss to pay out the cash requests. Then there was a run on the bank, SVB could not generate enough cash, and it was all over.

That’s the headline — but there’s something more serious — and also a potential opportunity.

A Growth and Opportunity Engine Still Needs Fuel

While that simple explanation may suffice for now, there’s something much more profound underneath it. Tech company long-term cash flow expectations and valuations were misguided to the point of being profoundly out of touch with reality. This cold reality is a slap in the face to venture capital’s ecosystem and may represent a systemic failure within that ecosystem.

Quite simply, valuations are down significantly, credit has dried up, and investment performance hurdles are much higher so capital availability is drying up. It is much more challenging for investors to put money to work, entrepreneurs are struggling, and a global economic growth engine is sputtering.

It is not a financial market failure, as we saw with Lehman Brothers because the scale and interconnectedness among financial institutions aren’t nearly as pervasive as it was with Lehman Brothers in 2008. But there is a significant impact on an entrepreneurial network and capital funding for new ventures that drive growth and prosperity. Silicon Valley’s growth engine and the sustainability of those very risky yet potentially high-return ventures are at stake.

Our Goal Is to Survive

As Jeremy Irons so famously put it in the movie, “Margin Call,” one firm’s survival, and more importantly, the partner’s net worth, matters more than even the integrity of the financial system and a cooperative effort to keep a financing engine functioning. As his character so aptly put it, “we live to fight another day.”

This kind of attitude would destroy the Silicon Valley ecosystem if investment firms subjected themselves to the “Tyranny of the Commons;” everyone is worse off if selfishness wins.

The Silicon Valley Bank failure could be Margin Call all over again. What a lot of people are missing is that Silicon Valley Bank‘s clients were startup and growth companies, not individuals. Those companies now have serious liquidity issues — cash that’s either tied up or potentially lost, and also no immediate source for bank financing operations and growth.

Less liquidity and few options — that’s serious enough for each company and potentially catastrophic for the Silicon Valley ecosystem.

The Ecosystem Must Survive

Many Silicon Valley venture capital firms are trying to step into this funding breach, and while investment banks and commercial banks such as Goldman Sachs and J.P. Morgan are likely to step partly into this breach, private credit funds such as Ares and Oaktree may place an aggressive role, there is a risk that there will be a significant shortfall. The real opportunity is for venture financing to provide liquidity and growth capital on a coordinated and substantial scale.

Cooperation

The answer is a pervasive, well-publicized, and coordinated effort from Silicon Valley’s venture capital firms to establish capital availability and a foundation for ongoing finance. With an ecosystem-wide availability for capital and credit and a cooperative message, unlike Margin Call, instead of being a firm that survives, the Silicon Valley ecosystem survives.

Now firms might not cooperate, and it may be a lot like Margin Call, but their best interests are served by the survival of the entire venture capital startup, growth, and credit market survives. It keeps the growth engine fuel pumping, raises the bar for all participants, and everyone wins.

We’ll see if this happens. Often what ought to be is not what is. In this case, the upward trajectory of an entrepreneurial ecosystem is at stake.