Hire an Extra Engineer With Better Cash Management
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Guest post by Scott Orn, CFA, Chief Operating Officer, Kruze Consulting
Interest rates have increased dramatically over the last year. That’s an opportunity for startups to earn a better yield on their cash reserves. You might earn enough to make an additional hire – or even more than one. So how can a startup take advantage of better interest rates to earn enough to increase headcount?
Just a few years ago, founders and CEOs didn’t worry too much about cash management. They put their operating cash in a checking account, and their cash reserves in a savings account and got to work on building their businesses. After all, interest rates were low and there wasn’t much point in trying to earn any yield on their cash. That’s all changed now. Cash management is critical.
To start, let’s clarify one thing. A startup founder’s primary cash management goal is preserving capital. You don’t want to tell your board of directors or investors that you’ve lost money that they’ve entrusted to you to build a business. That means no high-risk or volatile investments, like stocks or cryptocurrency.
There are still low-risk investment opportunities
Higher interest rates, however, create options to get a better yield on your cash through low-risk investments. Currently, one-year US treasury bills are paying about 5%. If your startup has $10 million in cash that you don’t need for the next 12 months, you could earn $500,000, enough to fund a couple of hires. For a startup with $50 million in reserve cash, a sound investment plan could earn an extra $2.5 million annually!
So how can startups take advantage of these interest rates? Start with your burn rate, which is the amount of money you spend every month. Ideally, you want at least 12 months of runway in liquid account(s) that you use to pay your regular expenses. Once you know how much you need for monthly expenses, you can develop a cash management strategy and plan ways to earn a return on your reserve cash:
Start with your bank
You should have six months of expenses in your operating account(s), that you use to pay regular expenses like payroll or vendors. Consider opening accounts at multiple banks for these funds based on how much your expenses run. Having at least two accounts makes sense, so you won’t miss payroll if there’s a banking issue. The recent bank failures starkly demonstrated the value of more than one account, but smaller issues like computer problems or outages can affect your ability to get to your cash, too.
Near-term cash is the amount you’ll need to pay expenses for an additional six months. Put these funds in liquid accounts that earn interest, like savings or money market accounts. Make sure your bank is paying you its best current rate on your business accounts, since banks can be slow to adjust your rates when there’s a rate increase. If so, a phone call could get you a better yield.
Many startups are placing larger shares of their cash at “global systemically important banks” which are the largest banks in the world. Considered “too big to fail,” like Bank of America, JP Morgan Chase, Citigroup, or Wells Fargo, these banks have to maintain higher levels of capital and liquidity and are subject to more rigorous stress testing. These banks do tend to have more limited customer service, so you might put enough cash for your immediate needs in a smaller bank with a better operational experience, and keep other cash in a large bank.
Maximize your FDIC insurance
With the recent turmoil in the banking industry, startups are more aware of the fact that FDIC insurance only covers $250,000 per depositor, per bank, per ownership category. That’s typically too low to cover most startups’ cash reserves. See if your bank offers an insured cash sweep (ICS) account that distributes your cash to other FDIC-insured institutions in increments of $250,000 to keep you fully covered. You can access and manage your funds from your regular bank.
Consider short-term, low-risk investments for your reserve cash
Most banks offer cash management solutions, which can help you earn more return without juggling investments yourself. For cash reserves, startups should look at holding them in short-term US government securities, such as treasury bills, or a government money market fund that invests primarily in T-bills.
Treasury bills. T-bills have maturities of less than a year, are backed by the US government, and are considered very low risk. Even if something happens to your bank, it won’t affect your T-bills. While T-bills can be bought directly from the government, that’s not practical for most startup CEOs. Your bank may have a partnership with a FINRA-regulated broker-dealer. Ensure you’re using a custodial account, which means your investments are in the startup’s name and not commingled with other funds by the broker. T-bills can be bought in maturities of one month to a year, and you could “ladder” them by staggering the maturities and then rolling them over into new T-bills if you don’t immediately need the cash.
Government money market funds. Government money market funds are mutual funds that invest primarily in short-term government securities like T-bills. Note: Money market funds differ from money market accounts (MMA). MMAs are a type of bank account and are FDIC insured, so you’ll run into the same issues with limits on FDIC insurance. The advantage of a money market fund over buying T-bills directly is that the fund managers will handle recycling the short-term securities into new securities as they mature, so you don’t have the administrative issue of rolling your T-bills over.
Create a plan
There are a lot of details to consider when you’re developing an investment strategy, and startup founders and CEOs should adopt an investment policy statement (IPS).
An IPS is a board-ratified investment plan for your startup, and it provides a roadmap for your investment strategy, as well as reassuring your investors that you understand your fiduciary responsibilities and are being careful with your capital.
You can review sample investment policy statements online (including ours), but remember that you should consult your accounting team, financial advisor(s), and legal counsel when you’re developing your investment plan. If you want to discuss your IPS, please contact us.