The Federal Reserve is hiking interest rates to combat inflation, and is telegraphing future hikes. So what does that mean for a startup that’s raised a significant amount of money, and has a large pool of cash?
Many banks and financial institutions offer cash management or treasury management solutions. Your startup can take advantage of suites of financial products that can help you balance your yields against potential risks, while making sure your funds are liquid and accessible.
Remember your cash management priorities as a startup founder:
- Preserve your capital. This is your highest priority – your investors entrusted you with these funds to build your business, and they don’t expect you to generate huge returns on that capita through high-risk investments.
- Maintain liquidity. Startups should be able to access your funds when you need them. Certificates of deposit, for example, require you pay a penalty if you cash them out early, so you need to balance the potential return against the possibility you’ll need the funds.
- Cost management. Accounts with high fees or high commissions can eat into the returns you’re receiving.
- Counterparty risk. This is the risk that your financial institution might default on its obligations to you. Banks, for example, insure your accounts through the Federal Deposit Insurance Corporation (FDIC) but only up to $250,000 per account.
What cash management options are available to startups?
However, with rising interest rates, there’s opportunity to earn more with your capital than you may be earning in your checking or savings accounts.
Let’s look at some cash/treasury management options:
Savings accounts. Currently you can get FDIC-insured savings with interest rates above 1%, so you should check to see if you can move your funds into higher-yielding savings accounts. Definitely shop around for the highest rates! Remember that FDIC insurance only covers $250,000 per account, so if your startup has a significant amount of capital, a single account may not be your best choice.
Network deposit services. For startups with large-dollar deposits that want greater FDIC protection, some financial institutions offer network deposits, where the startup’s deposit is distributed among a large number of banks to maximize FDIC protection. For the startup, there is only a single financial relationship with a consolidated statement. As interest rates rise, these deposit accounts will reflect the increases, so you’ll be able to maintain competitive rates of return on your funds.
Money market funds. Money market funds are mutual funds offered by investment fund companies that invest in highly liquid instruments like US Treasuries, government bonds, commercial paper, and certificates of deposit (CDs). These are high-quality investments with a short average maturity – 60 days or less – so investment risk is very small. The overall returns of money market funds are dependent on interest rates, which makes them a popular choice to park funds when interest rates are trending upward.
NOTE: Money market funds are NOT the same as money market accounts (MMA), which are interest-earning savings accounts offered by financial institutions and carry FDIC insurance. MMA yields are typically lower than money market mutual funds.
Bond/CD ladders. A bond or CD ladder is a portfolio of individual bonds or CDs that have staggered maturity dates. The bonds or CDs are timed to mature when the startup needs the cash. The ladder locks in the interest rate for the individual securities that make up the “rungs” of the ladder. That can be an issue, however, in a rising interest rate environment. If a startup purchases a bond with a 12-month maturity that pays 3 percent interest, and interest rates rise, those funds could be earning more return. So locking up funds may not be the best choice when rates are going up.
Talk to experts in treasury management
To take advantage of the different cash management options, startups should consult an experienced treasury manager at a financial institution. While it’s possible to invest in bonds or purchase CDs directly, cash management activities can be complex and would take significant amountsof time to manage. Kruze Consulting works with several banks that specialize in startup banking, and you can check out our reviews here.
