How To Protect Your Company from a Bank Failure

The collapse of Silicon Valley Bank has been described as “devastating for fintech” and a “sign of things to come” by financial sector naysayers. It’s neither. SVB’s failure was caused by poor investment management at the bank and reduced venture capital investments in the tech sector. Both are factors you cannot control, but you can plan for them.  

How do you protect your business bank deposits? SVB customers got lucky. FDIC insurance covers up to $250,000 in deposits. That’s pocket change in the fintech world. Sequoia Management, the VC firm that backed PayPal, Google, and Apple, had over $1 billion in their account. The FDIC chose to cover it all. That won’t always be the case.

Global pandemics are rare. The most recent one before 2020 was the Spanish Flu in 1918. The stock market has crashed twice in the past fifteen years. Credit card debt topped $1 trillion this year. The SVB situation is not unique like these events. There have been 561 bank collapses since 2001. Here are some tips to protect you from the next one:    

Tip #1: Look for a Bank That’s on a Sweep Network

There’s little doubt that Sequoia’s connection to the titans of the tech sector was a factor in the FDIC’s decision to backstop all SVB accounts. The situation also sparked a conversation about “sweep networks” that are being used by other banks to increase the limits of FDIC insurance. These networks eliminate the need for an FDIC bailout that might not be available.

Sweep networks give banks the ability to “sweep” funds that are over the FDIC limit into another FDIC-insured deposit institution. For example, a deposit of $500,000 could be split into two equal parts. The first $250,000 would be insured at the bank that holds the primary account. The second $250,000 would be FDIC-insured at the second institution.

Utilizing this concept, banks that are part of a sweep network can offer several times the base FDIC protection. That’s peace of mind for larger depositors. It also takes the pressure off small to mid-size banks because the distribution of funds lessens their chances of collapsing in a bank run. The sweep network can provide additional cash flow when it’s needed.          

Tip #2: Do Your Due Diligence on the Bank          

Investing in long-term bonds when the Fed makes it clear they’ll be raising interest rates is not the brightest move. That’s what SVB did. They also didn’t understand the capitalization of their target market. Fundraising for fintech slowed down in 2022. SVB should have seen the bank run coming in 2023 when cash-strapped fintech firms needed to draw on their reserves.

A deeper dive into the months leading up to SVB’s collapse reveals that it was inevitable. Internal reports from past employees reveal a plethora of complaints centered around poor technology and the treatment of clients who didn’t meet certain standards. One SVB manager described the technical back end as “bubble gum and wires.”

The irony should not be ignored. The darling bank of the fintech sector was technologically challenged. David Selinger, CEO of Deep Sentinel, and a depositor at SVB, says that was never more apparent than when the bank was handling PPP loans for their customers. “The tech looked like it was built in 2002,” Selinger reported. “It simply didn’t work.”

Tip #3: Set Up a Non-Bank Source of Funding

Banks aren’t the only place to tap into funding for your business. There are other types of institutions that can issue business loans and lines of credit. Some of these sources are private, so they’re not insured by the FDIC. That’s the downside. The upside is significantly higher. Private funding could mean lower interest rates and more flexible terms.

A good example of this is venture debt. It can come in the form of a loan, but a line of credit offers better security against a potential bank failure because you’re not taking the money until you need it. A line of credit is an approval for a specific amount with a “draw period” and a “repayment period.” Think of it as a piggy bank to be opened when needed.

Venture debt can be kept in reserve for emergency situations, or it can be used to fund an expansion or inventory purchase. Banks offer LOCs also, but rates are currently high and credit approvals may be based on the personal history of the applicant, not the creditworthiness of the company seeking the funding. Venture debt funds can eliminate both those problems.    

Tip #4: Stay Liquid: Maintain a Current Ratio of 2.0

Liquidity is one of the metrics used by investors and potential partners to determine the financial health of a business. The “current ratio” measures the company’s ability to pay its short-term liabilities within the next twelve months. It’s calculated by dividing current assets that will be converted into cash within the year by current liabilities due within twelve months.

A current ratio of 2.0 means your company has twice the assets it needs to pay your current liabilities. That gives you a certain level of security, but not if you keep all those assets in one place. This is where using sweep networks or additional deposit accounts can add another layer of protection. Speak with your accountant for advice on how to do that.

Bank failures happen. The collapse of SVB should not have come as a surprise. Volatility in the banking industry created the circumstances that made it possible. Poor decision-making and inadequate technology pushed them over the edge. Your business can protect itself from getting caught up in a similar situation if you follow the suggestions outlined here.