Silicon Valley Bank was a state-chartered commercial bank in Santa Clara, Calif. A run on the bank’s deposits caused it to fail on March 10. The collapse took only the matter of days. SVB was the 16th largest bank in the United States: its failure was the 2nd largest in history (following Washington Mutual’s closure in 2008).
SVB catered almost exclusively to information technology and biotechnology startup businesses. Because SVB relied heavily on one type of client, it was able to use its niche marketing to build a who’s who of mid-sized clientele. Its stock price rocketed higher, trading more like the stocks of its technology-focused customers than its bank brethren. The 40-year-old bank attained a whopping market capitalization of $43 billion by November 2021.
However, grow by the sword, die by the sword. SVB’s stock price plunged in sympathy with the tech sector to $19 billion by February 2023 — before the real trouble began. Now, equity holders are poised to be wiped out.
The collapse of SVB reminds me of the business practice known as the “Switzerland Structure.” The Swiss are known to value their independence. They don’t use the Euro currency despite being sandwiched between France and Germany.
And they never officially picked sides in the world wars for fear of tying their wagon too closely to one geopolitical regime over the other. The Switzerland Structure grants your company independence by mitigating your reliance on any employee, customer, or supplier.
The value of your company is driven by adhering to the Switzerland Structure. Your company is worth what someone is willing to pay for it. Acquirers want to invest in businesses that inoculate themselves against danger; dependent on an employee, customer, or supplier is a liability. A potential acquirer may not expect your business to be wiped out, like SVB, but they will significantly discount your company’s value due to its increased risk.
Most business owners understand the hazard of relying too heavily on a few key employees. Think about the impact on a company if the top people left. There is value in employee skill sets, and you’d do well to secure that competence. However, the risks of being dependent on suppliers and customers are considered less frequently.
Take control of your suppliers
The depositors of SVB were too reliant on using the bank as their supplier of money safeguarding. They risked losing their assets due to the bank run. However, that’s not a perfect analog because we don’t want our small businesses forced to act as forensic accountants when determining where to deposit their money. However, between SVB and pandemic-related supply chain issues, you appreciate the risk.
Having only one or two suppliers means you could be at risk of an industry change. Or your supplier could build its own sales force and compete directly with you. If you find yourself too dependent on a supplier, invest in your customer relationships so that your customer thinks of themselves when buying from you, not your supplier.
If it’s in the realm of possibility for you, you can vertically integrate with your supplier. Or you could negotiate an iron-clad contract specifying quantitative and qualitative measures of product and service.
To reduce the uncertainty of a supplier concentration, diversify your vendors so that no one supplier dominates the supply chain. This could cost you basis points on margin in the short term, but you’ll avoid the valuation discount from acquirers.
Diversify your customer base
SVB increased its risk, in part, by exposing itself primarily to one type of client – aggressive startups. These startups typically rely on funding rounds from private investors to ramp up their growth. That is such a common phenomenon that a term is ascribed to the pace of that spending – the “cash burn rate.”
The cost of capital has increased significantly since the Federal Reserve began to raise interest rates on March 16, 2022. Funding became more challenging and pricey for these aggressive startup customers. Startups needed to tap bank deposits that were previously dedicated to more traditional spending (payroll, rent, utilities).
These withdrawals dramatically reduced the assets held at the bank to the point customers weren’t sure if their cash would be available to them when they needed it. The bank experienced a run on its deposits, and regulators shuttered the organization.
Customer concentration dangers are not limited to high-tech concerns. Tom owned a laundromat in Great Barrington. Tom raked in the dough for a decade, mainly because Acme Medical (not its real name), a local health care agency, brought its laundry to Tom’s laundromat. Acme accounted for 80 percent of Tom’s sales. Then, Acme decided to wash laundry onsite and stopped dropping off their bags at Tom’s. He became irrationally furious at Acme. Tom had not secured a contract; he merely relied on the habit and ‘’loyalty” of Acme.
How do you reduce your reliance on a critical customer?
Acquirers will consider it a problem if more than 15 percent of revenue comes from one customer. To reduce sales concentration, you could grow your revenue from other sources, including selling more to current customers. Doing that makes your one big client a smaller share of overall revenue.
Alternatively, you can scrutinize what you sell to that one big customer and stop selling the things that are low margin; sell them only higher margin products and services. Some large clients have deep relationships with their vendors. That large client begins to demand customization and concessions beyond the sweet spot of your product because they are comfortable with you. Soon, you end up with little pricing authority and a shrinking margin but not much addition to the bottom line.
Would the Switzerland Structure have saved Silicon Valley Bank? It’s hard to prove a counterfactual, but it seems so. Developing independence from those three constituencies (employees, suppliers, and customers) decreases your company’s risk and increases its value.
This article first appeared in the Berkshire Eagle on March 20, 2023.