Riding the Waves of Crisis: From SVB to Vesttoo, and Beyond

The sudden vacuum left by Vesttoo's scandal points toward a need that remains real.

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Aug 02, 2023

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Hi there,

I distinctly remember September 2008: I was wrapping up a term at an investment fund, working on early and growth-stage investments in financial and insurance technology firms. The Global Financial Crisis (GFC) was at its zenith. I will never forget the day that Lehman Brothers' green-and-gold lights went dark, and thousands of people poured into the streets carrying boxes filled with remnants of their careers. Shortly afterward, my firm's Managing Partner announced an indefinite pause on all investments.

A crisis is like a rock impacting water. In the case of the GFC, the rock was actually a boulder, and the waves rippled across the global economy for years.

I rode one of these waves, first helping SecondMarket develop new product lines in illiquid financial assets and addressing gaps in the capital markets. Then, I became an entrepreneur, leading the U.S. arm of Funding Circle, an international platform for small business loans, which we took public in October 2018.

As I build my second startup, the tech insurer Vouch, I have come to appreciate that successfully navigating crises isn't a spontaneous act of leadership, but a skillset that requires cultivation and refinement through practice. Many of us, whether consciously or otherwise, start our entrepreneurial journey by riding a wave birthed from crisis. But the situation will inevitably flip, and if we aspire for a long career in leadership, we must master the art of crisis management. On average, a founder may face 2 to 3 severe exogenous crises per decade (these days it seems more like 1-2 per year), and responding thoughtfully to these crises is a crucial skill-set for any leader who wants to stand the test of time.

The first wave of a crisis

The first wave of a crisis is remembered for its magnitude and immediacy. The first skill involved in crisis management is learning to paddle swiftly to evade damage and seize opportunities that arise from that immediate dislocation.

The sudden collapse of SVB rocked the heart of the tech ecosystem. Founders paddled fiercely over a long and scary weekend to escape the potential impact of frozen funds.

Meanwhile, Brex, Mercury, and other digital challengers provided a masterclass in wave surfing, as they onboarded thousands of fleeing SVB customers through a combination of thoughtful messaging and astute adjustments to their offering, executed at breakneck speed.

The waves that follow

If the first wave demands responsiveness, the following waves demand foresight. We must scan the horizon for the waves that ricochet off banks and merge in unexpected ways, and do all we can to avoid being blindsided by these secondary and third-order impacts.

In the case of SVB and FRB’s downfall, there will be both continued ripples (for example, knock-on effects from the contraction in the venture debt market) and great opportunities – currently ones that many players, start-up and incumbent alike – are rushing to meet.

Vesttoo: a crisis in motion for Insurance & Insurtechs

This brings us to Vesttoo, a promising Insurtech startup that created a marketplace to connect insurance companies and institutional investors. The company grew quickly – in part due to meaningful dislocations in the overall reinsurance market (for example, driven by underwriting losses due to fire and hurricanes over the past few years) as well as the proliferation of Managing General Agents/Underwriters (MGAs & MGUs) seeking alternative capacity arrangements.

News surfaced on July 18th unmasking potential fraud amounting to $4 billion through potentially forged letters of credit offered to Vesttoo’s partners. Vesttoo's senior legal and financial executives abruptly departed and an investigation is underway. This is no GFC, but in certain corners of the market waves will certainly be felt.

An example of that is the action that AM Best is taking, the primary rating agency for insurance that is followed closely by all market participants as the de facto benchmark for determining financial strength. One week after the Vesttoo news surfaced, AM Best released a press release indicating that fronting carriers with exposure to Vesttoo were being monitored, and rating actions may be taken. The day following, they announced that fronting carrier Clear Blue Insurance was under formal review with a negative outlook for their A- financial strength rating. Then, as of this writing, an estimate issued by Morningstar increased the scope of the fraud to a potential $5 to $10 billion range.

We believe the first wave may not have crested yet.

Next, we might see disruptions to ordinary companies, as brokers across the country transition clients with impacted policies into safer coverages. For the Insurtech leader, already navigating the hardest reinsurance market in over a decade, this will no doubt be a further test of resilience. Companies in the space can anticipate further scrutiny of fronting carrier capitalization, robust Enterprise Risk Management (ERM) standards to properly diligence letters of credit, and the potential for regulatory changes in the Insurance-linked Securities (ILS) market.

In spite of these consequences, we must acknowledge that Vesttoo, with its unique marketplace model, aimed to solve a critical problem that sat at the intersection of the insurance and financial sectors. They brought insurers and investors together on a single platform, increasing transparency, liquidity, and access in the often opaque and hard-to-navigate reinsurance markets.

The sudden vacuum left by Vesttoo's scandal points towards a need that remains real.

Entrepreneurs might look at the original problem with fresh eyes, armed with the knowledge of Vesttoo's missteps, and consider how a safer solution might be engineered.

Consider, for instance, the specific opportunity that arises in addressing the fraudulent letters of credit, a cornerstone of Vesttoo's operations. A fresh ERM solution could focus on allowing counterparties to diligence and validate letters of credit more efficiently, providing a safeguard against future fraud. “Instant LOC verification” is just one of many ideas that FinTech entrepreneurs should be entertaining now.

As we at Vouch navigate the Vesttoo crisis, we are carefully examining both the challenges and opportunities that lie ahead, and we hope you are doing the same. The waves may be daunting, but, as skilled surfers, we know that success comes from accurately reading the waves, choosing our path, and paddling with determination.

—

Sam Hodges

Co-founder & CEO of Vouch, Empire Startups Contributor

The Empire Startups Contributor Model is a chance for writers and thought-leaders in the FinTech space to share their ideas and expertise with our ever-growing audience. Our model is is merit-based and does not offer monetary compensation.

You can check out more of our contributors here.

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