A situation that many VC startups face is managing their cash. Your company may have received a large infusion of capital from a funding round, and those funds are sitting in a bank account. While you don’t want to take a significant amount of risk with this money, is there a way you can use the cash more productively? One option is to use a bond ladder for cash management to achieve some return while maintaining liquidity.
What is a bond ladder?
A bond ladder is a portfolio of bonds that all mature at different times in the future. It’s an alternative to cash sitting in your bank account. While cash in your bank account is safe, it typically pays a very low interest rate. If done correctly, a bond ladder can help your startup manage cash flow and get some income from your capital.
Using your budget and financial model, you know how much runway you have and what your cash out date is. With that information you can use your cash to buy bonds or certificates of deposit (CDs), and stagger their maturity dates. With some planning, you can structure the “rungs” on your bond ladder so that some are maturing at your key milestone dates, when you need the cash.
Typically you will want a mixture of CDs and US Treasury bills (bonds with short maturities, from 13 weeks to one year). Depending on your timeframe, you may include other securities like zero-coupon bonds which have maturities as short as six months. Since CDs are insured by the Federal Deposit Insurance Corporation (FDIC) and Treasury securities are backed by the US government, these are extremely safe investment vehicles. You can also consider corporate bonds that are very highly rated, like AAA or AA bonds. Ideally the right mix will outperform the yield you would receive by keeping funds in a bank account.
These financial instruments are also fairly liquid if you run into any unforeseen expenses. You can generally cash out any of these investment vehicles in a few days if necessary by paying a small penalty.
How can you create a bond ladder?
The best method for startup founders is to consult a money manager. They have the expertise to work with you to build your bond ladder and structure the “rungs” to meet your specific cash needs and business objectives. A money manager will also be able to advise you on the best financial instruments to use in your ladder. If you need a recommendation, your accountant at Kruze Consulting can help you.
Your ladder should generally stay within a one-year to 15-month timeframe. Even if your runway is longer than that, you should be careful about investing for longer periods. You could encounter issues that require more money than you originally anticipated. Cash management is critical to startups, and while keeping your funds safe should be your primary consideration, a bond ladder can help you protect your capital and potentially gain some additional yield. For a startup with $20 million in funding, that additional yield might help fund another hire. If you have questions about bond ladders, please contact us.