Startup cash management and FDIC insurance

Some startups are raising significant amounts of funding now, routinely raising 10, 20, 30, or even 40 million dollars in funding rounds. Those funds need to be used to develop your startup’s products, hire employees, purchase equipment, pay for facilities, and other day-to-day company expenses. But until you need that money, where should you keep it? That’s a big part of cash management, and startups and founders need to understand how to handle cash reserves. 

Remember that company officers are fiduciaries, and have a responsibility to manage the company with care and diligence. So putting that money in a bank account seems prudent, right? Bank deposits are insured by the Federal Deposit Insurance Corporation (FDIC), which insures funds in bank accounts. The FDIC was established after the Great Depression to guarantee that money in banks was safe, and it also regulates the deposit institution. 

Can FDIC insurance protect your startup’s funds?

FDIC insurance is restricted. The FDIC insurance standard amount is $250,000 per depositor, per insured bank, for each account ownership category. And if your startup is one that’s raised millions, $250,000 of insurance isn’t enough to protect that amount. 

So what can you do? One limited solution is to open different accounts at different banks, but that clearly doesn’t scale well. For $10 million, you’d need 40 accounts to protect the entire amount with FDIC insurance. There are, however, some options you can pursue:

  • Network deposit services. There are services that will divide large deposits among a network of banks to maximize your FDIC insurance. You typically deal with one institution, which manages your networked deposits and provides you with a single statement. 
  • Bond ladders. A bond ladder is a portfolio of individual bonds (usually Treasury bills or bonds) or certificates of deposit (CDs) that are timed to mature in sequence, so that cash is available at different points when your startup will need it. 
  • Money market funds. There are mutual funds that typically invest in short-term securities, like Treasury bills and certificates of deposit. Money market funds are investment vehicles, unlike money market accounts. Money market accounts are FDIC-insured up to the $250,000 limit. Money market funds are not, but they are reasonably “safe” based on the lower-risk types of securities in their portfolios. 

Will your startup ever need FDIC insurance?

There’s another aspect to large financial institutions that affects your cash management decisions. Money market funds are not “guaranteed” like deposit accounts, but the reality is that many of these funds are huge. One money market fund with J.P. Morgan has over a trillion dollars under management. 

And that puts these large financial institutions into the “too big to fail” category. The federal government does not want a bank to fail and for people to lose deposits at all. And as we saw in 2008, the practical playbook for the government is to take control of a failing bank or deposit institution before it goes bankrupt, initially through the Office of Thrift Supervision (OTS), and now through other federal agencies, including FDIC, the Office of the Comptroller of the Currency (OCC), the Federal Reserve, and the Consumer Financial Protection Bureau. 

The failing institution will typically be sold to a healthy bank. For example, in 2008 the OTS took control of Washington Mutual (WaMu) and sold it to J.P. Morgan Chase. J.P. Morgan Chase acquired the banking subsidiary of WaMu minus any unsecured debt and equity claims. So the federal government cushioned the purchase so that J.P. Morgan Chase would take control of WaMu’s banking business and make sure the depositors did not lose money. And this happened repeatedly – failing institutions were quickly taken over and merged with healthy banks.

That’s really your final layer of protection. In the event of a crisis, the federal government will step in and make sure your money is protected. So FDIC insurance is important, but in practical terms, the federal government will execute a number of tactical options before a depositor needs to worry about FDIC insurance. So while we get questions about the FDIC limit, it’s probably not going to apply in most cases. If you have other questions about cash management for your startup, please let us know