Automation helps founders avoid the basis point yield trap

The recent banking sector developments that sent founders scrambling for places to diversify their cash reserves left markets wondering if the Fed would follow these events with another rate hike. As I’ve previously written, the Fed avoids surprises. Sure enough, the interest rate is now 25 basis points higher, raising a question for founders: How should this hike impact the way I manage my company’s cash?

The wrong answer is to give in to the urge to spend hours emailing different banks in search of the highest yield payout and agonize over hunting for an extra five to 10 basis points of yield. As a founder with limited time, you are better off managing other parts of the business. Cash management automation has reached a point where you and your finance team no longer have to spend hours to achieve yields that reflect the current market rate. Here’s an exercise to illustrate why you are better off spending your time elsewhere.

Let’s say you have $25 million from your recent fundraising.

Next, assume you spent four hours of your day rate shopping and ended up squeezing out an extra five basis points through an amalgam of providers. We’ll increase it to 10 to really emphasize the point. You have uncovered an additional $25,000 per year, but does this provide a net-negative impact on your organization when you consider the time you and your finance team spent generating this value?

Early on, when the Fed first began raising rates to combat inflation, it made sense to prioritize your time to implement a sophisticated treasury strategy that moved you from 1% to 4% APY – $750,000 in new value per year. However, now that you have reached competitive yield rates that reflect the current Fed funds interest rate, spending your valuable time trying to squeeze out additional value is a mistake.

Harvard Business Review built a handy calculator that estimates the resource cost of your finance team members searching for ways to increase the yield on your company cash. The first half-hour they spend evaluating cash management providers will cost $35 per $100,000 salaried employee — and this calculation only covers the initial actions of talking to your current bank or sending an email inquiry to new providers. It does not include the follow-up conversations, internal meetings deciding whom to use and the subsequent steps involved to get things moving.

These opportunity costs can snowball the more you hunt for those extra basis points, reducing the marginal benefit of that additional $25,000/year gain you uncovered. This effort also carries unnecessary risks: As we have seen in recent months, market conditions could shift dramatically, exposing your asset holdings to significant downside almost overnight, even with a provider you have painstakingly vetted.

Once you hit competitive yield levels, adding additional return might require you to invest in higher-risk assets. Your mental calculus then becomes a balance between generating extra marginal yield and putting your funds at higher risk of depreciation.

If you look back at some digital assets that provided exceptional APY last year, some eventually collapsed and companies lost some or all of their operating cash. This negative outcome points to three crucial realities of cash management that can haunt your startup if you don’t acknowledge them.

Three factors that can quash your cash management efforts

Optimizing cash stores is an essential practice in a non-zero interest rate environment. Each dollar can help offset costs and extend your company’s life, and the benefit only grows as you become more cash-flow positive. However, three factors commonly keep founders from experiencing these benefits:

1. Lack of cash management experience: Cash management requires knowledge and experience with how to design and implement a strategy; you can’t rely on principles of testing and iteration that come in handy when building a startup.
2. Lack of time: From initial plan development to implementation, it can take days and weeks to research providers, seek and evaluate proposals, and conduct reference checks — and that’s before you begin to manage your portfolio actively.
3. Introduction of unnecessary risk: No investment is 100% secure, so even the most basic cash management setups have some level of risk to them. This risk becomes amplified as you add assets that introduce additional risk in exchange for a chance at squeezing out inconsequential yield beyond competitive market rates.

These three considerations point to an essential truth for founders and startup finance teams: You are not hedge fund investors. First and foremost, your primary objective is to attain a reasonable, market-competitive yield that provides ample security and bandwidth for you to focus on operating your business. When you consider the five tactical steps involved in cash management, you quickly see why the previously outlined factors matter.

Five steps to effective cash management

1. Diversify for counterparty risk. Spread cash reserves around different custodians that offer access to short-term government securities to maximize security and diversification.
2. Maintain control of your assets. You don’t technically own the underlying holdings when using “off-the-shelf products” like money-market funds, mutual funds or ETFs. You only own shares of those asset tools. This means you have the risk of the fund manager or ETF provider coming on hard times — or them deciding to close the fund/ETF you are invested in, adding unnecessary risk.
3. Develop an investment policy outlining how you will invest surplus cash. Create clear guidelines and first principles that are easily understandable by your team, investors and other key stakeholders. An investment policy serves two main functions: Your internal team sees how cash will be managed so everyone moves in the same direction, and your investors will understand you are managing your idle cash prudently and conservatively.
4. Monitor market trends and reinvest assets per your investment policy. The treasury market constantly evolves as new economic data points provide the Fed with indicators of how their inflation-control efforts are progressing. Your asset investment strategy must reflect the realities of today’s market, not yesterday’s.
5. Reinvest assets at market rates. This way, you always know you are earning what the market is paying.

A word on automation

If you are a time-strapped founder with a finance team already managing an immense workload, I have good news: Treasury automation has proliferated in recent years to the point where every step I outlined above can be executed for your team — from allocation and monitoring to reinvestment and liquidity balancing.

Automation has removed any need for you to shop around for rates that put your capital in unnecessarily risky assets. It frees up time for you to focus on your business while getting assurance that your recent funding round is earning a competitive yield that extends your runway.

When evaluating automated cash management providers, here are four questions that will help you select the right cash management partner based on the steps outlined above:

1. Does the provider help you create an investment policy, or will you be on your own? A basic investment policy template only goes so far.
2. Can you buy and hold assets directly, or are your funds invested in funds and ETFs?
3. Do you get assistance with program planning and balancing risk tolerance, liquidity and acceptable returns?
4. How many steps in the cash management process I outlined above will be automated, saving you time to focus on your other responsibilities as a founder?

At the heart of cash management automation is the Pareto Principle, also known as the 80/20 rule, which states that 80% of the results come from 20% of the effort. The goal is to optimize your time and resources as a founder by removing the tedious tasks that go into effective cash management from your workload, thus increasing your efficiency and freeing time for your finance team to focus on value creation.

In a fast-paced startup environment where every second counts, automation can ensure your cash reserves are earning market-competitive yield, and you aren’t spending valuable time hunting additional basis points that will leave you behind in the long run.

This material presented is for informational purposes only and should not be construed as legal, tax, accounting or investment advice. Under no circumstances should any of this material be used for or considered as an offer to sell or a solicitation of any offer to buy an interest in any securities. Any analysis or discussion of financial planning matters, investments, sectors or the market generally are based on current information, including from public sources, that we consider reliable, but we do not represent that any research or the information provided is accurate or complete, and it should not be relied on as such. Our views and opinions are current at the time of publication and are subject to change.