Pippa Passes: SVB, Alien Motherships, Mathematical Constants, New Physics, Manhattan Project v2, CBDC, and Indra’s Net
I’m in the Middle East this week, taking time to understand some things that take time to understand.
The world is panicking about the demise of Silicon Valley Bank, but for the wrong reasons. Yes, a whole lot of businesses had raised capital that will now take years to retrieve, if ever. It’s just like Lehman Brothers in one respect. It’s about captivity and re-hypothecation. This situation is exactly what we should really be thinking about. First, why is the financial world full of captive models? In the world of banking and hedge funds, you have to place cash on deposit with a bank that raises capital for you or gets you new clients. That’s the meaning of Prime Brokerage. The bank raises money for you and gets to keep it on deposit to improve its liquidity and increase their size. This is how Lehman Brothers hurt so many hedge funds. They all had vast sums on deposit with Lehman when that bank went bust. Ultimately, the hedge funds got their money back because the funds never belonged to Lehman in the first place. They were just holding them on behalf of clients. Except, it seems the team at Lehman started to trade with this “dormant” money on their own account. Why not make some money on the side? This is called re-hypothecation. It’s not legal. Finding and restoring the re-hypothecated funds took years.
SVB has a similar issue. Note that the Chief Administrative Officer of SCB had been the CFO of Lehman’s Global Investment Bank, so this approach would have been familiar. The business model was a winner for everybody till it wasn’t. All the Silicon Valley start-ups wanted was capital. All the PE funds wanted was a filter so they didn’t have to waste time meeting every single wannabe founder. All the successful founders wanted access to the coolest deals in town so they could make more money faster. SVB became the broker that met everyone’s needs. If SVB raised the capital for you, there were conditions. One of them was, “but you must keep the cash with our bank.” So, that’s what the start-ups did. The start-ups were captive. There was no choice. What happened from there remains to be seen. Most likely, most of the start-ups simply never delivered the returns. SVB, like everybody else, thought that one unicorn would offset a ton of donkeys (not to malign donkeys). It turns out that’s just not true.
All this raises a huge question about how we fund the most critical and fragile part of the economy, which is the start-up sector. It also raises huge questions about start-ups. Why is the failure rate so high? Does it need to be that high? Does it have to be so hard to raise money?
My impression from working with a wide array of start-ups across multiple sectors is that there are many points of failure and very little conspiring to support their success. Even successful start-ups with naïve founders usually find that the VCs simply throw them off the bus as soon as the business gains momentum. Some founders get to stay on, but they are exceedingly rare. Founders usually get chucked. At worst, there are almost no successful start-ups. The failure rate is well over 90%. Why? Because the world is full of people who do not understand the difference between a brilliant product and a brilliant business. We call them founders. A few of these founders figure out how to convert a brilliant product, even a mediocre product, into a business. I keep being tempted to write a book called “But My