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Startup Stress

It was the ‘go to’ for startups and venture capitalists, seemingly solvent and compliant with regulations, but the fall from top 20 financial institution to obliteration was fast for Silicon Valley Bank.

For one former hedge fund manager, and founder of N2 Technology, Derek Watson, the headlines triggered a wave of anxiety as the emotions of 2008’s financial collapse surfaced again.

Writing for mentl, he recounts his experiences, explores the issues, and offers his learnings for founders from the crisis he lived through.

And, while the situation appeared to improving this week, with the US and UK government moving to support depositors, Derek calls out a shocking lack of compassion for the thousands of startups who were left locked out of their accounts and unable to pay their works.

When I read the news last Thursday of the impending collapse of Silicon Valley Bank, it triggered all the emotions of 2008. The stress, the anxiety, and that feeling of having the rug pulled out from under you all came flooding back. In 2008 I had a Hedge Fund, a convertible arbitrage fund, to be exact; we managed around $500 million and with leverage, had a market exposure of over $2.5 billion dollars, spanning pretty much every financial instrument available. From May to August 2008, I pulled as much exposure as possible from Morgan Stanley, Merrill Lynch and Lehmans, plus many other banks, and moved it all to Goldman Sachs and Credit Suisse (First Boston) to look after our investors.

But we didn’t reduce exposure to the market, just positioned the book for a bear market, and what ensued next, wow, this is how severe the situation was and the run on cash. We had bought a huge amount of insurance on company bonds we owned, and as the market collapsed, the insurance became cheaper, now, when you think you know what you are doing and events like this happen, it is very humbling. 

There are two levels in managing other people’s money: the first is to make great risk-adjusted returns, and the second is to understand and manage the secondary risks. As money managers, it’s our duty to protect our clients’ assets and manage risks effectively. Even if it’s difficult and confusing to cross morals and ethics in a crisis, we can’t rely on plausible deniability to avoid responsibility. Trust is essential in this industry, and we have to take our obligations seriously.

While the chances of a systemic event of the magnitude of 2008 were highly unlikely, the event in isolation means whatever plans or preparations you had made beforehand would not have been sufficient to deal with the panic that followed. Much of it was driven for the self-preservation of the people that understand how the financial system works and how to play the game, where there is only an upside in making the correct business decision and where the downside is just a blemish on your moral conduct. I know this one very well, and I am morally, ethically and business-wise very happy with the choices and actions I took in 2008 to protect our stakeholders.

The sadness and empathy I feel for all the founders and the SVB team affected is overwhelming and further compounded by the weight of schadenfreude blitzing social media. I am no stranger to schadenfreude after 2008, when the world’s press, politicians and literally everyone went all-out to play the blame game on the hedge fund community. Currently, the best and worst of humanity are arguing it out on a public forum, the polarisation of left vs right, rich vs poor, pure panic being hyped into mass contagion risk with comments like “extinction-level event for startups” from business leaders in the ecosystem to sarcastic jokes “Silicon Valley gets what it deserves! Screw tech, startups and VCs!” Sent from an iPhone via Twitter and Instagram, (w an ARM processor instruction set by Marvell, code repo by GitHub, delivered via Cloudflare, while driving a Tesla Model 3 and Slack/Gmail w co-workers), this has just stoked the #nobailout hashtag to trend with so many people jumping all over it including some prominent political figures.

The self-serving, clickbait-filled arguments from both sides only fuel righteous, antagonistic debate. Meanwhile, those most affected by the situation – the everyday depositors – are left feeling stressed and anxious. To make matters worse, some people seemed to adopt an ‘ostrich’ mentality, pretending everything will be fine despite the clear risks and challenges.

We know the men and women, mums and dads, family and friends, who use SVB to do their daily banking to pay their rent, mortgages and food. The people we brush elbows with every day now have no idea what tomorrow might bring. All the founders, who have taken on the huge risk of building a business and employing people, the core of our society who keep capitalism and our hopes and dreams alive every day, these are people hurting right now.

On a personal level, I find it incredibly shocking that so many people with a voice resorted to this level of communication with such a lack of emotional intelligence, empathy and compassion.

With all this in mind I feel we should actually be celebrating social media, it has become the medium to offload, and in amongst all the schadenfreude, there were also many messages of support, even if most were just at a sympathetic level or some supportive signature list. There were some useful resources being shared to solve the short-term problems that were the root of all the stress and anxiety. It is way better than in 2008 when it didn’t exist in this capacity, or maybe that was because, as a hedge fund manager, I was enemy number 1.

Founders in shock

We have seen the five stages of shock play out in 48 hours, the rollercoaster of denial, anger, bargaining, depression and acceptance. This will have long-term effects on the many people caught up in this. But, now as we sit here on Monday reading through the Fed’s solution, here is a practical and realistic take on it:

The game is what the game is; first and foremost it is the responsibility of the Government who regulates it and issues the rule book.

Did SVB step outside of the rules? It does not seem so.

Did SVB mismanage the bank?  100% they did; it is almost laughable how poorly managed the book was, but this view is easy to say for an outsider.

From the management’s point of view, they are pushed and incentivised to return shareholder value and make profits, so the game and its rules are misaligned from the outset, which is why the boom and bust cycle will continue.

Moreover, regulators allow you to buy assets with short-term depositor cash, meaning 24-hour liquid cash, and use it to buy 10-year mortgage backed securities that can be locked into a hold-to-maturity account where any losses don’t get taken into account. As a result, misalignment of interests can be easily seen.

The responsibility and onus is 100% on the US Government, which is elected to make the rules and manage the system. If financial institutions play by these rules and such scenarios occur it is on the government, and regulators who oversee the rules, no one else. So their actions over the weekend should not be glorified or thanked, they are just responsible and necessary actions to clear up their failings.

And on the subject of failings, I see that depositors have not been segmented into two groups:

For everyday depositors who use the bank for basic financial services such as paying bills and taking out loans, they shouldn’t be expected to understand the complexities of the fractional banking system. They rely on the bank to provide what they say they will provide and shouldn’t be dragged into the game.

Professional investors who failed to manage money and risk properly were included in the same category as regular depositors, which is contradictory. These investors have a responsibility to their clients to manage risk effectively, and without consequences for their failure, it only encourages more lackadaisical risk management and oversight.

The impending disaster that grabbed the attention of so few people outside of the echo chamber that is VC and Startup world this weekend, has by all intents and purposes been averted, and fortunately, my anxiety has started to subside. However, this does not mean that it is over by any stretch, and other banks will have a run on them as they all play the same game and mismanage their duration exposure. The solution for SVB has given license to the larger banks to strangle the smaller banks and consolidate the industry upwards.

Founders’ stress

There are some very easy and practical things founders can put in place to reduce stress through events like this:

  • 1. Know your investors. Are they doing their job correctly?
  • 2. Get a fractional CFO on board who can understand your primary and secondary risks, and get some advice on easy steps to take to reduce them.
  • 3. Have your mentors and advisors on speed dial.
  • 4. Concentration risk is very real and make sure you are not caught up in the echo chamber.
  • 5. Do not get involved in the blame game but seek positivity and practicality.
  • 6. Keep your ego in check; if there is one thing I took away from 2008, it is that ego is your number one enemy in emergencies.
  • 7. Accept that certain things are out of your control and concentrate your energy on what you can control.
  • 8. The market is always full of hubris and greed that leads to taking stupid risks that ultimately fail. Stay humble.

I sincerely hope people look back at this and realise how far we need to come with compassion and empathy, along with practical solutions focused on the right people, to take precedence over righteousness, and the will to be right by shouting louder than the next person.

Unfortunately, with VC’s putting out antagonistic posts like this:

“To the schadenfreude brigade. I do understand. I get the PoV. But if at any time you want to stop using products or services created by a startup or funded by venture capital. Feel totally free. I will quite happily bring over some flints to start fires in your cave.”

We have much further to go than I think anyone could have anticipated.