Cash Policies for Startups

I heard a rumor on a call the other day that some startup companies are starting to keep balance sheet cash in higher yield instruments such as corporate debt. This is apparently becoming trendy again as private companies do $25m+ rounds and end up with a bunch of cash on their balance sheets.

This scares the shit out of me. As a high growth startup, I think you should be focusing on maximum protection for your cash, even if the yield is 0%.

In 2001, we had several companies lose over $1m (including one that was public that lost $7.5m) in corporate bonds, which were being pushed on startups by the various banks as “safe.” We also had at least one case of a mess in the 2008-2009 time period with someone with one of those fancy action rate securities that froze cash for a while (they eventually got it.)

And when I say “lose”, I mean the cash just vaporized. I remember seeing the email about the public company that had $7.5m disappear from their balance sheet. No one on the board was even aware that cash was tied up in corporate bonds, let along risky yield seeking ones. It was a powerful signal, at which point I actually spent time learning about the corporate debt market. It’s a good case of “it’s nice until it isn’t, and then it’s really not nice.” It’s probably even more severe today.

Don’t fall into this trap. It’s worth double checking your cash / treasury policy at your next board meeting and making sure your board knows where your cash is. And, more importantly, if you are CEO, knowing where your cash is.

Be careful out there. The scary monsters are starting to hang out at the bar again. They look really cute, cuddly, and intriguing, until they don’t and chomp down on a random body part.

Hint: US Government Treasuries are good.

  • And presumably, if you are using a Sweep Account, what class of investment your excess cash is going into?

    • Yup. Go one level down and make sure you know what your bank is doing.

      • DaveJ

        It’s actually very important because large balances like that are not covered by FDIC, which is a problem in a real meltdown, particularly in traditional venture banks, which are probably not considered “too big to fail.” All cash should be in a sweep into U.S. Treasury bill money funds.

  • Tyrone Niland

    Being in a private equity and advising a number of small businesses, I’m forever stressing to management just how important cash is. I follow this closely with how important it is to have quick access to cash.

    Comes down to business fundamentals – don’t keep cash unnecessarily tied up in customers, suppliers or stock; and when you have cash on your balance sheet , keep it safe and accessible.

  • “The scary monsters are starting to hang out at the bar again. They look really cute, cuddly, and intriguing, until they don’t and chomp down on a random body part.”

    Ahhhhahhh very nice

  • reminds me of when I pondered taking private stock in one of our partner firms instead of the cash revenue they were giving us. floated it to you guys and Clavier came back within a second saying something like “dude, we invested in your company, not for you to play some other market.” short and sweet. made the point.

    this trend would scare the shit out of me too.

    • I remember that conversation well. And it was short.

  • I have always been a fan of CDs and using balance in the account to get as many favors and fee credits from banks as possible. You can also push smaller banks to take care of your employees real well and get them lots of service. No interest rate can match dividend of happy employee, who is getting taken care of by the bank, like he had quarter million in his bank account. Even helped one get favorable mortgage rate, by telling bank president I will move the funds, if they don’t take care of my top producing engineer 🙂

    • Just make sure your duration is very very short and that you aren’t in a concentrated position where if the bank fails, you are screwed.

      • Brad, FDIC publishes at risk bank watchlist every quarter. At least for me, that is list I visit as part of due diligence and annual audit of my vendors.

  • Well and importantly said.
    It comes down to greed. Entrepreneurs – make your money from making great products which win customers. Don’t try and be a hedge fund.

  • Matt Kruza

    Yeah, that is insane and CFO of such companies honestly should have to explain to you or other investors where their “cash” is .. hopefully treasuries or something similar. If not, they should be fired, full-stop. Such a lack of judgement to put into high risk funds (even lower risk corporate), that I would NEVER want someone like that making such a decision to be the financial visionary / counsel for the CEO.. shudder. I mean if you are picking up even more than 50 extra basis points you have to consider the duration / interest rate / or credit risk. So 50 basis points on $25 million (and that’s assuming they are dumb enough to put it all in that) would be $125k per year. Seriously? You are trying to be a $billion+ company and you are taking on untold risks for $125k. Idiots. . But in all seriousness have them walk you through the analysis I just did. Did it in 3 minutes, without a calculator, without looking anything up.. if a startup with serious institutional investors has a CFO who can’t do that.. I would seriously question both the CFO and CEO, and almost certainly fire the CFO on spot (not CEO because likely they just were not aware / trained to think of it as I just did)

  • Brad in Switzerland and Euroland you might even end up paying for that safety !

    Surely this is a case of inappropriate funding instruments.

    Where for example do you “park” newer funds that are not yet placed ? – should treasury not be something a wise VC might handle for their investments? (As some help with HR, back office etc)

    • No way should your VC be involved in your treasury function as a company. That sounds like a recipe for disaster at multiple levels.

      • @bfeld:disqus – Real thanks for concern.
        It does not apply to us as we are bootstrapped and near b2b2b profitability (will only take eventual funding for growth of our proven proposition, when we are sure we need to jump outside Europe – this make take a few years yet!)

        However if you replace my naive “handle for ” with “advise to” – does it not make sense? – presumably ou have to sit on fairly large fund deposits (or are they only called down when needed)?

        (We would also never think of exposing ourselves to unwaranted investment risk – we want to be lean enough to remain capital efficient – so we do not see having an “embarassment of cash to lodge somewhere”)

        • We only call the money down as we need it so we don’t have huge balances. But we behave the same way – capital preservation is the only thing that matters.

  • Treasuries have no credit risk, but they still have interest rate risk. If the Fed decides to raise rates and you need your cash before your bonds mature, you’re going to lose money.

    My guess is that most of your stories involve either someone buying bonds they didn’t understand (junior debt of less capitalized corporations) or buying long duration bonds and not being able to hold to maturity. If you are buying senior debt of well capitalized firms and you can hold to maturity (short term debt) your risk shouldn’t deviate that much from treasuries.

    Also, you could also look at your firm, analyze what environment you need to be a going concern and see whether that environment would be likely to have a default on the part of your debtors. If not, it doesn’t matter whether your debtors default. You are going down anyways.

    • I should have said “short term US treasuries are good.” Basically, don’t own anything that you can’t hold to maturity, and don’t hold anything that has a term longer than a few months.

      Most private companies don’t have the treasury function that will understand what they are buying. As a result, they should be focused entirely on capital preservation.

      • Maybe a generalization would be: don’t do things you don’t understand outside of your core business.

        • Well – that’s a good life generalization, but there are lots of people who THINK they understand lots of things they don’t actually understand.

  • If I was on the board of a startup that had that sort of financial instrument on the balance sheet, I’d do two things. First, tell them to divest and reinvest in short term treasuries. Second, if the CFO didn’t want to do that, move to have him fired.

    I traded my own money for years and years. You never knew when you were going to take a big hit. It was possible to manage risk, but still, there was the possibility of a 4 standard deviation event every day that you couldn’t anticipate. Hence, when you put a position on, you had a lot of excess cash to back yourself in case the Black Swan decided to swim into your pond that day.

    Financial advisors told me I was stupid. Then one day I lost $350k in five minutes and had to cover it with cash….that day.

    If I had chased yield and went into corporates, I would have taken a massive haircut getting out of them, and it would have taken a lot of time to redeploy the cash and I would have been out of business for a few days.

    Obviously, startups are at risk for the types of drawdowns that trading accounts or hedge funds are at risk for. But they are tangentially at risk.

    From an investor in the startup perspective, it’s hard enough to raise cash from LP’s or make it yourself. It’s a shame to see it wasted on corporate bonds, haircuts, commissions getting in and out etc.

    To this day, the only debt I ever carry is a mortgage, and sometimes I am uncomfortable with that.

    • Well said – great reinforcement.

  • “I used to think that if there was reincarnation, I wanted to come back
    as the president or the pope or as a .400 baseball hitter. But now I
    would like to come back as the bond market. You can intimidate
    everybody.” – James Carville

    • Awesome quote – sounds like classic Carville.

  • DaveJ

    I would add to this the fact that interest rates are extremely low on all but the longest term and highest risk securities. Even a three-year investment grade corporate bond returns less than 1%. Consequently, anyone who is trying to get a meaningful return out of that cash is either taking a lot of investment risk or interest rate risk. There is no “pretty safe” investment that has any short-term return.

  • Aaron Bird

    Great article Brad. What are your thoughts on bank savings accounts? Is the FDIC $250K max coverage also a risk not worth taking (for balances much over $250K)?

    • That risk isn’t worth taking and it’s easy to manage it by laddering across accounts if you want to take this approach.

  • firasd

    Your line about scary monsters reminds me of Marc Andreessen saying:

    “A very large number of people came out of investment banking, came to Silicon Valley in 1999, cause they thought they were gonna make a lot of money, and in 2001 they all turned around went back to New York and created the credit crisis.”

    • They’re back!

      • Funny. Sacca had a little rant at the Launch Conf about his sincere desire the tech market would crash so that the posers and bankers would be expunged from our industry.

  • Ron Rymon

    I have not seen anyone mentioning using MULTIPLE banks. Not to mention multiple currencies, multiple countries, etc. Of course it depends on the amount you have vs. cost of managing multiple accounts, but if I had $25MM in the bank (my companies are usually a lot more capital efficient than that), I would put it in 3-4 banks, and at least one overseas. If you are exposed to net expenses in other currencies you should be even more interested in keeping some of the money int these currencies as well (the dollar just moved 20+% on the Euro for example, and can move in the other direction as well).

  • Can’t agree more with Brad here. We are seeing lots of private firms lobbing their precious cash out as far as they reasonably can in corporate debt in the hopes of earning more money on their cash. I really doubt any of their board members are encouraging this. Rates are rising, sure, but so are the losses that you risk if you cant hold that cash to maturity. As rates rise, the value of these Hail Mary bonds drops, and you better be able to hold it to maturity or its principal loss a-la 2008 all over again.

    A lot of company portfolios we see at other asset management firms hold a bunch in prime (aka corporate risk) money funds earning close to nothing, and then lob the rest out as far as they think they can manage, with a big valley of nothing in between. Since they can’t earn anything for their clients any other way, this seems to be how they justify themselves as asset managers.

    I’m increasingly convinced that each firm should keep it abundantly simple: stay in cash and cash equivalents (90 days max) using U.S. Government money funds or the underlying investments in those money funds, namely U.S. Treasuries, agencies and repurchase agreements over-collateralized by the same U.S. Treasuries and agencies.

    With this 100% US Govt approach you can still earn close to 1/2%, and if you want to earn more, can pick an choose longer investments when and if they seem worthwhile.

  • Why would you invest Other Peoples Money? You’re a startup, not a fund or a VC or a Wealth Planner or… *shudder* A Corporate!

  • Citizen

    Weaponizing the balance sheet….completely inappropriate for a young high growth entity. Whats worse is that “high yield” today, is 3 – 5%. If your “convenience yield” of having the cash available, is lower than that “high yield”…you’ve either got too much money or your start-up isn’t working..yet.

  • Stefan Fencl, CFA

    In an era of debt ceiling fiascos, a portfolio made up entirely of US Treasury bills still has measurable risk. During the fall of 2013, liquidity for US Treasury bills evaporated. Similar circumstances, though not as dire, occurred in 2011. And it may happen again. Treasury is currently operating under “extraordinary measures” as the debt ceiling was reached a month ago and Congress has failed to raise the limit. Private estimates suggest the Treasury will exhaust these measures by October 1, 2015. Having some short-term, high quality corporate paper in a portfolio (which didn’t suffer a liquidity shock in 2013) may be appropriate.