Benjamin Döpfner
It doesn’t matter how much users love your product; every founder knows that if you run dry on funds, you’re done. In today’s tightened funding environment, this is happening more and more often.
Operating in unpredictable markets is what first taught me the art of treasury management. It can be a lifeline and a safety net, which can sometimes be make or break for a startup during its most pivotal growth junctures.
Simply put, treasury management is the task of managing a startup’s capital and orchestrating cash flows. At the core of my strategy for my startup is a trifold objective: Safeguard cash, optimize liquidity, and scout for sound avenues to put idle cash to work.
It’s also about forecasting, about envisioning the cash needed to fuel the daily operations today and projecting into tomorrow.
Massive corporations have the luxury of dedicated treasury teams. For startups, driven by the mission of scaling, we often find ourselves in a tight spot. We can’t pour the same magnitude of time and resources into it, which can lead to a haphazard approach to treasury management.
This haphazardness can inadvertently expose hard-earned capital to a myriad of risks, one of them being the corrosive power of inflation, especially when cash sits stagnant and undiversified in barely breathing interest rate accounts.
How to calculate your cash position: The foundation for effective treasury management
Before diving into the options for managing your corporate cash, let’s first determine what actually counts as “liquid cash” to run your business. This is the cash that a company has on hand for immediate use, whether to run payroll, cover operating costs, make investments or tackle unexpected expenses.
Calculating how much cash you have might seem obvious, but it’s often not as simple as the amount you have in your bank accounts. For example, just because you’ve earned revenue doesn’t mean you actually have this cash on hand. Accounts receivable — the money that your customers owe you — isn’t liquid cash until it’s actually paid.
One common mistake that startups make is to count all earned revenue against expenses. But timing matters, and cash that you haven’t received is not liquid cash. It might be the case that some of your customers pay you late and others end up not paying at all. This needs to be taken into account when calculating your liquid cash.
A good treasury function is able to periodically observe both balances and cash flows across all of a company’s financial accounts with a high degree of precision. From there, it becomes possible to get an accurate insight into key financial metrics, such as burn rate and trend, runway/zero cash date, distribution of assets in various accounts, and key revenue and cost drivers. More context enables better decisions.
But understanding cash and liquidity is one thing. How can you begin to manage it?
How should startups manage idle cash?
The key to developing a successful treasury management strategy is understanding the difference between strategic cash and operating cash, and developing a definition that works well in the context of your business.
Operating cash can be seen as everything that your company needs to function for the next six to eight months. This includes salaries, rent, marketing costs, etc.
Strategic cash, on the other hand, is cash that your company won’t need for a longer period of time. This can be set aside for future investments, acquisitions, new product development and other longer term initiatives.
Having a sense of your forecasted cash needs can help you to determine where to leave it. Some operating cash can be kept in an account that you can draw from whenever you need it; this means that you’ll always have enough on hand for short-term payments. Strategic cash, on the other hand, can be strategically invested in fixed income instruments to earn a higher yield.
Managing your operating cash
Often, startups manage their cash by simply depositing it all into a business checking account or savings account. As your company grows, it may make sense to open multiple checking accounts for different purposes. Checking accounts make the most sense for ongoing operations such as operating costs and salaries.
However, there are a few things to watch out for when choosing the right place to leave your money:
- There may be fees for monthly maintenance, transaction fees, or for out-of-network ATMs.
- There may be a minimum deposit requirement, or a minimum balance maintenance per statement cycle.
- Some accounts limit the number of transactions, withdrawals, or deposits you can make in a certain cycle, or limit their amounts, which can prove frustrating.
- Not many business accounts offer a compelling yield when compared to low-risk investment options such as treasuries. Some banks that do may be running a short-term promotion to win new customers or aren’t able to sustain those higher yields for long periods owing to the nature of the banking business model.
The average checking account rate in the U.S. stood at a negligible 0.03% in 2021. By July 2023, even after an aggressive year of rate hikes by the Fed, it had only risen to 0.07%. But with inflation at historic highs, money left in a checking account essentially sits idle, getting gradually burned by inflation.
Finally, given the recent meltdown of SVB, First Republic and other startup-focused banks, finding ways to protect your cash is vital. Startups need to double down on protecting their cash more than ever before, particularly if it sits in a small- or medium-sized bank. FDIC insurance offers protection on cash up to $250,000 in the event of the bank’s failure, but there are other options that could provide companies more than the standard FDIC coverage and help diversify their coverage.
For these reasons and more, startups should consider opening checking or savings accounts at a “too big to fail” institutional bank with a long-term track record and strong capital position, but only use these accounts to maintain their operating cash.
Managing your strategic cash
Corporate treasurers have trusted fixed income strategies for their cash reserves for decades. Some popular investment choices include:
- S. treasury bills, notes, and bonds: Treasuries are backed by the U.S. government and are historically seen as some of the lowest risk investment options.
- Money market funds: These are mutual funds that invest in lower-risk, very short-term securities, from government-backed securities and obligations to corporate repos and commercial paper.
- Certificates of deposit (CDs): These bank deposit accounts have a fixed maturity rate and typically offer higher interest rates than regular savings accounts.
- Corporate bonds: Investment-grade corporate bonds are loans that investors give to financially stable public companies, which they are expected to pay back with interest.
These four options each have different benefits and risks. Let’s take a closer look at each.
Treasuries are short-term, conservative and liquid investments that are backed by the full faith and credit of the U.S. government. They come in a few different forms, with maturities ranging from 4 to 52 weeks (T-bills) to several years (T-notes) or decades (T-bonds). Given these are government guaranteed, they carry virtually zero default risk (unless the US government defaults) and are popularly referred to as “risk-free assets.” Additionally, the treasury market is very liquid and positions are easy to buy and sell if you need the money before the bill matures.
Money market funds are mutual funds that invest in low-risk, highly liquid instruments such as U.S. treasuries, government obligations, commercial paper and CDs. They have short-term average maturity, often 60 days or less, which makes them low risk. There can also be some yield variability, with minimal returns in periods of low interest rates, and they are not FDIC insured. However, their high liquidity and low risk makes them a popular choice as part of a diverse treasury management strategy, especially institutional-class funds with low fees (expense ratio) that aim to maintain a constant share price at all times.
Certificates of deposit (CDs) are time deposits offered by banks that allow you to invest your money at a fixed interest rate for a fixed period of time. They are FDIC insured up to $250,000, making them very safe. CDs lock money in for the duration of the agreed term, so withdrawing money before the maturity date may not be possible or may trigger a penalty, so they are best for cash that won’t be needed in the short-term.
Corporate bonds with a lower risk of default are called “investment grade” because they are considered safe enough for most investors, including large institutions such as pension funds and insurance companies.
Corporate bonds typically tend to promise higher returns than T-bills and also pay regular interest. This can be great for startups looking for regular cash inflow. However, this type of investment can carry a higher chance of default and can be less liquid than T-bills. Their price also fluctuates more with changes in interest rates. Such risks can be reduced by diversifying overall assets, as well as diversifying by using bond funds that invest in dozens to hundreds of bonds versus just a few. With the right mix of assets, companies can have a mix of short-term and intermediate bonds, and they can combine corporate, treasury, and municipal bonds.
Using laddering strategies to keep your cash liquid
Treasury ladders are a way to stagger the maturity dates of your T-bills, bonds or CDs to ensure that some of your strategic cash will mature when you may need it, according to your company’s key milestones. Typically, you will want a mixture of maturities with different timescales. Treasury ladders, if well planned, can help startups avoid being caught off guard by rising interest rates that can cause the price of bonds to fall.
Simplify your treasury management
It can be hard to keep on top of fluctuating interest rates and cash flows. Automating your treasury options can increase visibility and control while reducing risk, all while saving time. Common services include:
- Cash visibility and forecasting.
- Swift electronic transfers between different accounts.
- Liquidity and investment management.
- Detailed insights on financial data.
Tech platforms can give smaller companies the power of an entire treasury management department in one platform at a low cost, compared to hiring an entire treasury team. Because every penny counts for startups, it’s worth considering several aspects when evaluating ROI (return on investment).
Weighing the risks
All market investments are bound to carry some risk. But by choosing low-risk, fixed income instruments and combining those in high liquidity strategies on a short-term horizon (typically one month to three years), startups can access the yields they deserve while maximizing safety.
There may be higher yielding options available. But it’s often not worth it for startups to chase high-risk options with the potential for high returns, mainly because they may perform poorly in challenging market conditions, which tend to be unpredictable. High-yield crypto accounts, for example, are unappealing because they are often uninsured and suffer from high price volatility.
Another big risk factor is the strength and stability of the institution where your assets will be kept. Here, it may be advantageous to work with SEC-registered investment advisers (RIAs), who operate under strict regulatory safeguards and are subject to oversight from the SEC (Securities and Exchange Commission) and FINRA (Financial Industry Regulatory Authority). RIAs like Vesto are required to entrust the safekeeping of your assets to a qualified custodian and are restricted from having access to your funds.
This way, startups retain the rights and access to their assets at all times, and entrust them to a large institutional custodian that’s in great financial shape.
Custody accounts, which are brokerage accounts, are also subject to a higher insurance coverage of up to $500,000 (including up to $250,000 on cash balances) from the SIPC (Securities Investor Protection Corporation), and some of them may offer companies opt-in access to extended FDIC insurance on cash deposits as well.
One size doesn’t fit all
One of the benefits of a treasury management platform like Vesto is the high degree of customization. What works for a pre-seed stage company is not going to work for a growth-stage company with hundreds of millions in the bank. Vesto works directly with companies to create a custom proposal that matches their financial situation and takes into account their own investment restrictions, board reservations and cash projections.
As a founder, your top priorities for your cash are to:
- Preserve capital.
- Maintain liquidity.
- Generate a meaningful return.
Switching to a treasury management system can help transform your idle cash into a strategic asset.
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