Meet the Expert: Venture Fund Banking with Sam Heshmati and Vincent Timoney of Citizens Private Bank

0:00Welcome back to another episode of Venture Unlocked, the podcast that takes you behind the scenes of the business of venture capital. I'm your host, Samir Khaji, and today we have another Meet the Expert episode where we are joined by Sam Hishmati and Vince Timoney from Citizens Bank. Sam and Vince have long histories in the banking sector, having worked at both Citizens, First Republic, and then before that Silicon Valley Bank, and they were actually teammates of mine at First Republic before I left the banking industry in 2021. I wanted to catch up with them to understand what it was like on the ground floor when the regional banking crisis was happening in 2023 and how much the banking industry has changed since then for both startups and venture funds.

0:40We also talked about the different products and services that funds should think about to help accelerate efficiency and growth. Having had been a banker for nearly 23 years, it was nice to take a short trip down memory lane to discuss the latest about the sector. I really hope you enjoy the show and let's dive into the episode now. Samir Kaji is the CEO and co-founder of Allocate. Allocate and Venture Unlocked are independent of each other. Any statements or references made by Samir or his guests regarding third parties, investments, or securities are solely their views and opinions and are not intended as investment advice or an endorsement of such parties or securities by Samir, his guests, or Allocate.

1:20Allocate or its clients may maintain relationships with, or investment positions in, guests, third parties, or securities mentioned in this podcast. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions.

1:58the banking sector three and a half years ago. And since then, so much has changed, of course, with the events of 2023, primarily with Silicon Valley Bank first going down, and then ultimately, JP Morgan acquiring First Republic out of receivership. And we've talked a lot about just the impact on the industry, venture, startups, private equity. And being on the other side of the the table as a startup entrepreneur. There were a lot of sleepless nights during that weekend when SVB went down, because a lot of folks didn't know what was going to happen and whether we were even going to be able to meet payroll.

2:38But I want to maybe turn it around to you guys, being in the trenches on the banking side. What was it like within the walls of First Republic during the time SVB and then ultimately FRB was going through all the hardship of 2023? Yeah, no, it's a good question and it's a lot to unpack because so much happened in a short period of time. But, you know, going back to the first week of March last year, when the news kind of broke on what was going on with SVB and potentially kind of the direction things were headed there. It's funny because on the First Republic side, and I've told this story to some folks in the past, but we were at our annual sales conference.

3:19So most of the First Republic folks that helped work with this part of the community were all in one place at one time. And we fundamentally were tracking the news closely. I'd say personally for me, probably a little bit more of a sensitive topic relative to a lot of others, having spent as much time I had at SVB, the initial thought was, oh, God, like I know the role SVB has played in the ecosystem for so many years, have a lot of friends there. And in a lot of ways, SVB was responsible for helping me get into this industry. I looked at it and I said, this isn't good. Now, at the same time, you could feel the energy in the room at our sales conference rising because people's phones started kind of getting pings on them and people were looking down and taking calls, leaving the room because there was SVB clients that were looking at FRB as a safe place to go to open up accounts and move some money out.

4:20So it started out as all hands on deck. And I remember running to one of the conference rooms at the hotel to come up with a plan. How do we get accounts opened quicker in an expedited way without cutting corners to help support the ecosystem? And so we spent the first day or two doing that. And then obviously, quickly after that, we noticed the energy was shifting towards questions around First Republic. And then we started getting a lot of, I'd say, concern coming our way around the viability of First Republic as an organization. So it was a little bit of a roller coaster. I'd say SVB's events happened extremely fast, it felt like, at a blink of an eye.

5:08The First Republic story was a little bit different because there were a lot of ups and downs. And I remember Vince and I sitting and talking to our broader team. And there were many, many days where we thought, okay, we can come out of this and preserve the integrity of what First Republic was. And then there were days where we were questioning it. And it lasted a long period of time. And I think in a lot of ways, that was probably good for us. I mean, we learned a lot. We learned a lot about our clients in a very positive way, the support that we got around the table. We had a lot of conviction and more confidence in the work that we had done.

5:49People were really, really rallying and rooting for us around the table because they wanted us to continue doing this work. And so it was good because we got all of that information and the decisions that we were making, nothing was done in a fire drill situation. We got to take time to make a real educated decision around what we thought the path forward needed to look like. And it's really interesting if you look back at that time, and a lot happened in a very short amount of time. And it wasn't just, of course, Silicon Valley Bank and First Republic, but we also subsequently saw things with Credit Suisse, of course, Signature Bank, Another institution before that was Silvergate, which was really more focused on the crypto market.

6:34But I think SVB was this real terminal moment in time whereby we saw SVB have the issues based on a lot of things happening at once. So, number one, we saw interest rates rise up almost at an unprecedented pace in the first six months, really, of 2022. The second thing was the fact that they had so many assets that were now held to maturity, right? So all of these longer-term bonds that they were buying, if they were to use that to take care of the deposits that were flowing out, you can create insolvency. And, of course, trying to raise capital at the time was very difficult. this was the first bank run that was driven both by, in some ways, social media and the fact that everybody could now transfer money through their cell phones, right?

7:25It wasn't going into the branch. So everything happened, I think, between like a Tuesday and Friday for SVB. It was a longer bleed down for First Republic, which, as you mentioned, Sam, at first was the beneficiary of getting a lot of people coming in, viewing it as a safe haven. But then ultimately, the regional, it started to spiderweb out to all the regional banks. After that, it seems like the banking world has changed. So what used to be a couple of large players, SVB and First Republic, focusing on fund banking now is a number of different banks. The cost of capital is way up. And the cost of capital, of course, is up because people no longer trust keeping money in a zero interest rate checking account that's not FDIC insured.

8:11And the incentive is not there because there's yield to be had. So maybe Vince, you've seen this at the ground floor as well. You've been through what I'd consider three financial institutions. How has the banking world really changed over the last year that people may not be aware of just looking from the outside looking in? Yeah. I mean, I think certainly, and Sam talked a lot about what happened in the early days there, just really education from clients on banks' balance sheets and what they're getting from their bank as a service provider. I don't think I've ever had to explain the fundamentals of banking and how banks actually operate more than I have in the last year, certainly in those couple of months afterwards.

8:53But going from starting every conversation from what's an ICS account, What are all your off-balance sweep options? What's the tier one ratio of your bank's balance sheet relative to the large regional banks? Those are questions that I think the three of us probably never had in the years that we've been doing this. But now that's become kind of part and parcel of almost every conversation that we have when we're talking to, whether it's a former client or a new prospect, in terms of how they're going to manage their cash. It's also no longer just, hey, I have one bank provider, right? Now, most of the folks are looking at, I need to make sure I have viable options if something like this Black Swan event were to ever occur again.

9:40I think that's certainly lessened in the last few months. And part of that is, and you just referenced it, Samir, for so long, there were two banks serving the broader venture ecosystem that were so good at what they do and so understood the needs of this industry that it was kind of a default for them to say, I know I have these two great providers. They're both going to be able to meet my needs. And so through that, I don't really even have to go out and evaluate other providers in most instances. And now we're at a place where a lot of that talent has been distributed to a variety of different banks.

10:15Some of those are very large banks that have constraints from a regulatory perspective about how they serve this industry. Some of those banks are much smaller. And so they're going to have their own balance sheet restrictions in terms of what they can do from both a lending perspective as well as a risk perspective. And then you have, again, that talent that's spread that's trying to figure out how much of what we did before can we replicate both from a service model perspective as well as from a product perspective. And there's a lot that I think, again, the broader venture ecosystem just got used to having of, hey, I can call my banker and have funds get moved in an instant.

10:50I can call and get an account created. There's all these workarounds that they got used to handling just because of the relationships that they had. And now that we're in this sort of post-crisis environment, it's almost relearning how we're going to serve this ecosystem all over again. Not only us as the service provider side, but I think our clients as well are still educating themselves on, all right, what's going to be my long-term banking provider? What are the solutions that are really important? To your point, cost of capital has obviously increased substantially. So something like a capital call line that's been so prevalent in this industry for venture capital and private equity firms over the last 15, 20 years, people are getting a little bit more thoughtful about, do I really need that product?

11:33Or if I do need that product, I need to be a lot more thoughtful about how I'm using it. How much do I really need? Should I take as much as possible per the limits of my LPA? Or should I be a little bit more thoughtful about how I'm going to practically deploy the capital over the next two to four years and be a little bit more constrained with how I'm using that line? And I want to come back to different products that the clients are using. And I'm going to maybe isolate a little bit on the fund banking clients, both from smaller emerging managers all the way to large private equity funds. And you're right.

12:11I think that the business of banking, particularly with funds, has actually expanded in terms of the number of players that are looking to cater to this audience. What used to be a monopoly with only SVB became a duopoly, perhaps with SVB and First Republic. Now it's perhaps a little bit more of an oligopoly with a number of different people. They splintered out to these different organizations. One of the things that's very clear from the conversations I've had, number one, you're right that the explanations of things like tier one ratio, we never talked about those. I spent a lot of time in March, April, and May of last year posting a lot of data around how should you think about it?

12:50What matters? And I think people are much more attuned to understanding the bank's balance sheet strength. One of the things that I wanted to talk to you about, about all of these different banks, because presumably there was opportunities to go to various organizations. I know the two of you were temporarily part of J.P. Morgan, but there's so many other banks that are doing this. I feel like FRB, First Republic, had a very unique DNA in terms of client service, the overall culture of how we used to all work together with our client base and each other. Why citizens? As Vince alluded to, there's a lot of education going on around banking as a whole.

13:31And our clients and prospects are now asking us different types of questions around the bank, strength and stability, etc. We expected that. I think early on when we were deciding or when we were evaluating where we were going to go, and I'll speak for myself, right? And Vince can jump in as well. But we looked at it and said, I have to be able to look at anybody in the ecosystem that I trust and respect. And I have a reputation as well. I have to be able to look at them in the eye and say, I put myself in your shoes and did that homework for you, that diligence. So we needed to be able to look at fund managers in particular and then obviously entrepreneurs as well and tell them look this is a safe and sound place at the same token um it's nimble enough to allow us to continue to do the work that we had historically done one thing that we noticed post svb um was there was a lot of disruption a lot of folks had gone to different platforms and in some ways that the ecosystem suffers in the near term, obviously, because there's a lot of disruption.

14:38But long term, it could be good too with different options and players in the space. It keeps everybody real honest and forces everybody to be the best version of themselves. For us, we needed, it was key to bring a familiar offering back to market. We looked at what had happened in the market and we just felt the flavors of ice cream that were out there were different, were a lot different than what people were used to seeing in SVB and First Republic. And we knew the work that was done and the feedback we had gotten from clients around the offering that First Republic historically had offered.

15:15And we fundamentally felt like we had to continue to be able to offer that. And so for us, it was, I think, two things. One is, how safe is the organization? And then number two is, are they going to let us do things the way we know it needs to be done to please this part of the ecosystem. And so Citizens as a whole, from a balance sheet standpoint, it looked a lot different than a lot of the banks that were in trouble over the course of last year. The deposit franchise, 70 % insured deposits, which is the inverse of what First Republic really was. So we looked at it and said, if we're underwriting to the worst case scenario, what is the flight risk associated with the the deposits on the balance sheet.

15:58And I can say I got really, really comfortable with where citizens kind of lied in that whole thing. The other thing was the commitment, obviously, to allowing us to do it a certain way and the commitment to the sector as a whole. And although we came in and we're providing a new set of offerings at the private bank level, and we can touch on that in a second, there are things that Citizens has been doing to invest around the fund and innovation sector with the acquisition of JMP Securities and Investment Bank, signaling that they wanted to double down in this sector. And if you look at the model that we have, the Citizens Private Bank is a new division or entity amongst the broader Citizens Platform where they have brought us in and put us under the private bank and basically said, we believe in the operating model that you had.

16:55We want you to continue to do that. And that was key for us because we've said this before, is we want to, we wanted to play the same sport, the same teammates. It's a different Jersey, but that same sport and being able to provide that same experience that we did at First Republic was a non-starter. We had to be able to do that. And, and Citizens absolutely stood out with its commitment and it's evidenced by the launch of the private bank. Maybe Vince, you can come back to something Sam said in terms of two key variables you're looking at. One is strength and stability of the bank, which, as you mentioned, came from the fact that the deposit franchise was incredibly strong, very insured.

17:37So that takes out the risk of potentially a bank run or anything like that because of the FDIC insurance on the vast majority of the balance sheet. Second part was being able to do things in a certain way to solve for the need for a certain sector. And let's talk about the certain sector where a lot of banks have had some discomfort with, which is working with emerging managers, smaller funds. Most banks will lend and they'll bank large VC, large PE funds, much easier to underwrite capital call lines, things like that. When Sam says, do it in the way we knew that we needed to service this industry.

18:20What does that mean to you? Yeah. Yeah. Happy to jump in there. So, you know, one of the things that was really important when we were looking, you know, where we could continue to serve, you know, the broader innovation economy was the culture of any bank that we were going to join. And, you know, certainly the culture of citizens was super appealing. You know, it's an entrepreneurial culture. You know, We had a lot of discussions with them about building something together, taking the best of what we had previously, and really layering in the things that Citizens is great at. There's a lot of things that they do and have capabilities to do that we never had before.

18:59But we needed to be sure that there was that willingness to build. And quite honestly, having spent time building a business, as you both have, and now doing that at the startup scene and now coming back over here, it's something that really aligns us with our clients who are also entrepreneurs and are also building something. And so we've really seen that first and foremost here at Citizens is that willingness to get into the weeds and figure out what did make our practice different, what really makes it so that you can be successful serving the innovation economy. because it is a little bit different than how large money center banks have done it historically.

19:39So talking through, for example, with emerging managers, those are often smaller funds, sub$100 million funds that are going to need a line of credit. What's the willingness to lend to an LP base where there are family offices, where there are high net worth individuals? What's going to be the appetite? How do you get comfortable with that? Is it a product that you can do in a reputable fashion that's going to give our risk partners the confidence that we're here and going to be doing this for a long time. So I think the ability that, again, all three of us have done this at multiple places, being able to take that playbook out, walk through that with the senior leadership here, walk through that with our risk partners, and get everyone comfortable that we are moving in the right direction has been huge.

20:28because as people are looking for a different place, unfortunately, when the events last year happened, I think we all knew that there was one community that was going to get squeezed probably more than any other, and that was emerging managers. And that's certainly played out as we've moved now here into 2024. So when I get a call from a former client or a prospect who says, look, I'm trying to figure it out. I'm raising fund two. I'm not sure what I'm going to do. To be able to say, look, the same product that you were used to having in 2022, 2023, we can do the same thing here. Is it exactly the same?

21:03Of course not. Times have changed, so costs of capital, among other things. But largely, we're going to be able to deliver that similar product set. And I think more importantly, that culture of being aligned with our clients and looking at, hey, we don't need to squeeze as much revenue out of you quarter over quarter. We're here for the long term. We want to be committed and aligned with you as you raise fund two, fund three, fund four, knowing that in this ecosystem, you know, a wealth event's going to happen very quickly. And that's what makes the private bank so special is that, you know, when that does happen for one of our clients, we want to be able to support them in multiple different ways, obviously, on the commercial and business side of the relationship, but also on the personal side and make sure that they have what they need to be successful now that they're in this new stage of their career.

21:51If I can look at some of the things that I've seen, And of course, over the last year, you know, I've had a lot of conversation. I almost feel like in some ways I'm back in banking, given all the inquiries I've been getting. But a lot of the emerging managers have, you know, when they've talked to me about banking, they've kind of said three things that really matter to them. And I want to get your take on it. The first is, obviously, does the bank offer the set of products and services that I need? Capital call lines, of course, are very difficult to underwrite when the underlying LP-based, and let's talk about capital call lines in a second, when the LP-based is family offices, individuals, which is the vast majority of the capital that's going into the fund ones, fund twos, especially when it's somebody that hasn't spun out of a big firm, right?

22:39It's not somebody leaving Lightspeed, but it's an angel-turned full-time investor. The second is the digital experience to make it easy to be able to transact and not having to spend a lot of time for them or their fund admin. And the third thing is around the intangibles. What else can you provide me as an organization that isn't around banking that can help me grow? And that's something that I know we've all spent a lot of time with, you know, both at First Republic and even before that at SVB, which is more of a strategic partner. Let's go and distill down into each one of those. The first one being, you know, the product set.

23:19So what are the products that emerging managers typically use? Yeah. No, I think the number one product that really has evolved over the last, you know, 10, 15 years is a capital call into credit. You know, we went from a time, again, thinking back, you know, maybe 15 years ago where, you know, maybe only half of the funds would actually entertain getting a line of credit. And now we've evolved to that place in 2021, where nearly 95 % of funds that come into existence, you know, for a variety of reasons are getting a capital call and a credit. If for no other reason, it's a great way to manage your LP base.

23:54It's a great way to streamline how you're running the fund. And so as we moved into the higher rate environment, I think we were all wondering, what would be the pullback? And largely as I've had conversations with LPs, both institutional and non-institutional, even with the increase in the cost of capital, they'd still prefer to have that line in place for those same reasons. So with that in mind, that was super important to make sure that we could continue to serve the market with that product. And happily, we're able to do that today. There's obviously checks and balances that go into why we're able to put that in place.

24:30Number one is going to be making sure that the LPA that that manager has in place is a very good one and has the right language within that document that's going to make us comfortable as a lender. So that's always going to be first and foremost. You mentioned that a lot of emerging managers are going to have family offices, high net worth is the complexity of their LP base. And so what we're looking for is what's the experience of those family offices and high net worth individuals investing into this ecosystem? How diverse is this LP base? Is it just a couple of LPs that are in there that are maybe friends and family?

25:04Or have you been able to go out and raise from family offices and high net worth individuals that are outside of your immediate network to prove that proof of concept so that we can get comfortable as a lender against the diversity of LPs that you've been able to bring in. And once we can get through that, it's also obviously looking at what is the investment thesis? How is this going to fit in the broader market? And so once we've seen that manager be able to raise$10 million or more, that's typically when we're ready to start talking to them about a line of credit because we know how valuable that tool is going to be for them as they progress.

25:38The second is certainly going to be... Vince, maybe just before we move on from the capital call, there's a number of people probably listening that aren't completely familiar with what a capital call line and what is the main use case. So maybe just providing a little bit of color on that before we move on. Yeah. The number one thing with the capital call line is you're bridging between capital calls. So rather than calling capital ahead of making your investments and then sitting on that that capital within your bank account as you wait to kind of figure out what you may or may not deploy as deals may or may not come together.

26:13Instead, you can draw on that line of credit over the course of typically one quarter. And then at the end of the quarter, you can call capital from your LPs for the exact amount of those investments and costs that you incurred in the quarter. So from that perspective, you're able to manage your LPs and kind of get them comfortable with, hey, on a typical basis, we're going to call between call it five and 10 % per quarter. That way, your LPs are not surprised when they're getting that capital call notice. They're well prepared for that, and they're going to perform on time. You're not going to run into any issues as a manager of that fund.

26:43So I would say that those are really the primary tools. Of course, venture is a unique industry. Deals often come together very, very quickly. So rather than having to wait on a capital call to come into the account before you fund the deal, it's great to know that you have that line of credit available so that you don't miss out on an opportunity if one does present itself very quickly, particularly when you're not the lead investor. Perfect. That's super helpful. And I know you were going maybe to the next product that often is used, which is probably even more complex to understand is the use case of why a management company line, who uses it, and what are they typically used for when it comes to emerging managers?

27:21Yeah. So a management company revolving line of credit, you could almost think about it as a large credit card, if you will. Obviously, it's not a credit card, but what it's going to allow you to do is, and I typically see it when a fund or a firm rather gets multiple funds under their belt, maybe fund two or fund threes, you're going to be having fees come into the management company. And that management company obviously has a number of different expenses, payroll being one of many, but you're smoothing out cashflow by being able to, again, kind of put all of those expenses onto that revolving line of credit.