SVB Bank Crisis: What Will Happen Next and How Private Equity Will Reframe Crisis into Opportunity

Sean Mooney:

Welcome to the Karma School of Business podcast. Today we have an impromptu special situation episode about the 2023 banking crisis, its impact on private equity and how PE navigates during times of crisis.
This episode is brought to you today by BluWave. I'm Sean Mooney, BluWave's founder and CEO. BluWave is a go-to expert of those with expertise. BluWave connects proactive business builders, including more than 500 of the world's leading private equity firms to the very best service providers for their critical, variable, on-point and on-time business needs.

What a week of back to the future? The weekend of March 18th gave me an unsettling deja vu feeling of 2008, except this one felt almost like an equal but opposite feeling versus my observations and perspectives back then. The bank crisis of 2008 primarily involved large banks and large companies that caused ripple effects downward to the rest of the economy. The bank crisis of 2023 is more about smaller banks and small startups causing butterfly effects upwards on March 19th of this year. I couldn't help but sense that I've seen this movie before. In fact, Michael Lewis has probably already started this version of it.

Just like a fateful weekend in 2008 on March 19th, 2023. I was confident that we were going to have a broadline bank run on the following Monday if the Fed didn't take quick and decisive action. I was actually planning on going to Chase Manhattan Bank to open a J.P. Morgan account so I could diversify our capital cross multiple banks. Thankfully, after a bit of a stutter step or two on Sunday, the Fed and the FDIC took action and calmed the nerves of likely the global economy. If they hadn't, I and many others were likely to move cash away from regional banks towards the life raft safety of the big three banks. Fortunately, I and many others didn't have to because the Fed restored our confidence in the stability of our deposits.

So now that order has been restored for now, I've spent a lot of time thinking about what happens next and how to find opportunity in the face of crisis. So here's what I think happens next. First, even though faith in the banking system has been reestablished for now, a number of regional banks will likely continue to be weakened over time by a gradual migration of deposits towards the big banks because of, "Just in case, why not?" It's not going to be a run on the banks, but it's probably going to look more like a jog on them. A number of smaller regional banks will have less cash in their vaults and thus are going to make fewer loans. So, what's going to happen is money supply in the economy is going down.

At the same time, the big banks, JPM, B of A, Citi, will be flush with cash, they are flush with cash, but they're going to pull in their sales and get more conservative on lending as their credit committees inevitably rule the roost, as they always do during times of fear and risk like now. Once again, money supply is going to go further down in the economy. The good news is that all this reduction in money supply should help with inflation. The bad news is if money supply retracts too much too quickly, we go from a problem of having an economy that was a flying out of control rocket ship to a problem of an economy that runs out of gas and goes into a free falling stall.

The number one thing I'm watching these days to understand sentiment and economic inertia is the yield curve, as the bond traders have always been the smart and clever people in the room. What the yield curve is telling me is that the Fed will continue to raise rates as it relatively focuses more on rocket ship inflation, and then just as the tip of the nose of the economy starts pointing downward and begins to stall, the Fed's going to fuel up and hit the gas in about 6 to 12 months from now to try to pull and avoid a stall. This will be very tricky for the Fed to manage through. It's going to be difficult, but not impossible.

For the private equity industry there is limited direct in the media impact on PE from the SVB, First Republic collapse. However, there will be downstream, secondary, and tertiary impacts. The biggest thing that will impact PE is that it's going to be harder for them to get leverage to support their investments as the banks, who will now increasingly be ruled by the credit committees are going to pull in their sales and lend less, and they've already been doing that in advance of this, expecting more of a normal course recession. It's just going to accelerate. While things will slow, the PE industry is not tagging out though their LPs expect them to make investments through economic cycles in both good times and bad, there's still a huge amount of dry powder ready to be invested. The private equity firms are going to be heavily focused on what I call the barbells of a deal market. It's those companies that can sell in any market and those companies that have to sell.

For the really good companies that can sell in any market PE's actually likely going to pay a premium, and what they'll probably do is over equitize the deals knowing that they can re-capitalize them at a later date when capital markets regain strength and or accept a lower risk adjusted return, feeling good about parking, a relatively safe low volatility, albeit lower IRR investment return. For the companies that have to sell PE will similarly over equitize them, but they'll be able to get these businesses at a lower price in compensation for the higher risk that they're taking on for a company that's fundamentally wounded. The private equity firms will be a life raft for these companies to live to fight another day and then provide them with all the resources they need to become successful.

Similarly, for PE's existing portfolio companies and these new ones, PE just as they have been doing for the last 18 months is going to surround their companies with every resource available to make them successful. The data is really clear. When times are worse, the PE firms in their [inaudible 00:06:45] perform best.

This brings us to the question of why, and really it's follow the incentives. The PE industry is kind of like the Oakland A's from the movie Moneyball for those of you've seen it. It's great movie with Brad Pitt if you haven't. The private equity industry makes their money by consistently delivering relatively low level returns at a high percentage likelihood. So like the Oakland A's hitting singles and doubles, they're trying to get two, three, even one and a half times returns, but they get it time after time. So in comparison, the VC industry makes its returns by swinging for the fences whereby they'll strike out 7 or 8 out of 10 times, but hit home runs 2, 3 out of 10 times, and that'll make up for all those losses, and ultimately that's how they did well over the last 15 years.

And so if a PE firm is only making two to three times their money or one and a half times their money on each deal, they can never afford to have a loss. So when times get tough, they run towards their companies with every resource available because they know they can't make up for a loss if the company fails. Thus, their companies outperform all others during tough times because PE firms need them to be successful during these tough times.

This brings us to the question of how do they do it? One of the things I love most about being with BluWave is that our core job is to make two other groups successful. One that has a need, another that has the skills. Well, serving more than 500 PE firms, the thousands of projects we equip over time tells a story about how the best business builders in the world do things, where they do them and why they do them.

The last time we had an economic crisis, sadly was not too long ago, it was during COVID, 2020. When we looked at our data, it was fascinating. As I looked at it in retrospect, the private equity industry's methodology as a whole looked a lot like a military decision-making framework called OODA loops, and this is a decision making framework that involves rapid cycles of gathering information, formulating the strategies, deciding what to do, and taking action. Now, the PE industry adds one more concept as it relates to businesses, it's this idea of having liquidity not to sit on it but to fuel action.

So when COVID hit in Q1 2020, the firms took action to maximize liquidity at their portfolio company, they did this first. We saw meaningful drawdown on revolving lines of credits, infusion of equity capital, et cetera. Now, they didn't do this to sit on it, they did it to fuel action. So what did we see next? In Q2 of 2020, they started gathering information to inform new strategies. So in Q2 that year, we saw an all-time high demand for strategy resources like market research firms and voice of the customer advisors. It was very uniquely, they were repurposing the resources that they typically used during due diligence to inform new investments on their existing portfolio companies. And they said, the world has changed, we need to understand what's happening so we can pivot and change our strategies with it.

With updated strategies on how to succeed in the new normal, we then saw resulting action to equip these strategies. The first thing we saw happen was a huge amount of hiring to bring in the skillsets that they needed to be successful with these strategies. In Q3 2020, we experienced a then all-time high demand for human capital resources as PE firms needed PE grade and interim executives specialized recruiters to get all sorts of new skillsets in there. I think if you looked at the narrative in the media, it was largely saying that PE was firing. What we saw from the front lines at BluWave, bringing the resources that the PE firms needed to equip their strategies to bear to the PE firms, we saw huge amounts of hiring.

From there, the PE firms continued to rapidly iterate through these loops to bring in new tactics to equip their strategies as times and strategies evolved over time as well. So what we saw next in the next quarter was a huge demand for operational improvement and procurement experts that were brought in to help them restart supply chains. It sounds like seems like a lifetime ago, but remember, the whole world came to a stop and we had to restart everything and we couldn't get enough things out of our factories, and we had to rebuild entire supply chains cause parts of the world were still shut down. And so we brought in resources for the PE firms to help them restart all of this and bring supplies back to their organization so they could get business started again.

Next, remember what happened? It was the great resignation. They iterated again through their decision making loops. And we saw PE firms bring in organizational experts to help them rebuild their workforces and retain their teams and keep them engaged and happy and communicate total rewards and benefits so that they could keep their teams engaged and bring them back as the whole economy was restarting again.

After that, they continue to iterate through their loops of decision making. Next, we saw them bring in pricing and procurement groups. What happened next was inflation, one of the big things that continues today that has put us through this whole chain of events that brought us to that fateful weekend in March. And so they were bringing in pricing groups and procurement groups, and they're saying, we're going to take on inflation. We saw them do this starting relatively early in 2022. They all saw it coming, so this wasn't something new. They're looking forward, they're gathering information, they're changing their strategies, and they're acting on them. They're not just sitting there and wringing their hands.

It's a certainty that PE firms have flipped their war rooms back on right now and are getting their teams ready to once again maximize liquidity, and they're always looking at liquidity, but right now they're going to look at it acutely. And they're doing that not to sit on it, but to fuel information gathering and form strategies and take action and rinse and repeat in a rapid, purposeful way. For PE firms, this is natural to them. They do it without even knowing they're doing loops, it's just part of the way they do their business. They do this because of the way the incentives have been structured in the industry, rewarding consistent levels of moderate success in never letting your companies fail. Any company can and should do the same.

BluWave, ourselves, uses these OODA loops frameworks to navigate through times, and we are doing them. We've gotten very tactical, we're gathering lots of information, we're quickly informing strategies, and we're pivoting. And this doesn't change for us really anytime, but we do it in a much more rapid succession during times like now. For those interested in learning more about the general kind of OODA loop process, I think it's great. It's really impactful for us as decision makers at our company. I encourage you to Google Colonel John Boyd and OODA loop, we'll also put a link in the episode notes to show you where to find more about this.

If you're a BluWave client and would like to know more about how this decision making framework was activated specifically in the context of PE, please give your BluWave account manager a ping, and we'll provide you a very detailed report exactly on what happened over this process in 2020, '21, '22, so you can see exactly what happened in the data.

One of my favorite sayings that I think I've been saying way too much over the last three years is, this to shall pass. It always does. During times like now, great companies are made, great companies will evolve out of this, not only in private equity, not only in the greater economy, but also in the venture capital industry. The next Amazon is there, the next eBay is there, and they will rise from this challenge, from this crisis as Phoenixes and do amazing things through the world, and we're already seeing great companies come out, as we've seen with AI and all sorts of other things. So they're great businesses that will come out of this. It'll be the tenacious ones, it'll be the ones who get back to basics. Every company can and should do well during this time if they're willing to take action and reframe risk through the lens of opportunity.

So at the risk of sounding salesy and not intending to be. If you're inclined to take action and you need resources to not only survive but thrive and reframe this time into something that turns into an opportunity, please contact us and we'll do whatever we can to equip you with the exact private equity grade third party resources you and your companies need to be successful.

So hopefully this quick episode here informs you a little bit about what happened, why it happened, but also what the private equity industry will do next and what you can too. Onward.

That's all we have for today. For more information, go to bluwave.net. That's B-L-U-W-A-V-E.net. Please continue to look for us anywhere you find your favorite podcast, including Apple, Google, and Spotify. We truly appreciate your support. If you like what you hear, please subscribe, review and share. In the meantime, let us know what we can do to support your success.

Private equity insights for and with top business builders, including investors, operators, executives and industry thought leaders. The Karma School of Business Podcast goes behind the scenes of PE, talking about business best practices and real-time industry trends. You'll learn from leading professionals and visionary business executives who will help you take action and enhance your life, whether you’re at a PE firm, a portco or a private or public company.

BluWave Founder & CEO Sean Mooney hosts the Private Equity Karma School of Business Podcast. BluWave is the business builders’ network for private equity grade due diligence and value creation needs.