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The bankruptcy of the Silicon Valley Bank caused a lot of stress for many startup founders. Despite US financial regulators stepping in and taking care of customer deposits, the incident has shown that financial markets remain unstable.
In the midst of a banking panic, Signature Bank suffered bankruptcy as Credit Suisse is taken over by its competitor UBS; First Republic Bank customers recently withdrew over $100 billion.
To avoid getting sucked into such a bank run, startups should focus on improving their cash management and maintaining strong relationships with banks. This is what VCs will pay more and more attention to when deciding to invest in a startup.
Here are four tips startups can take to minimize their financial risk.
Tip #1 – Invest in multiple banks
When the economy is unstable, the likelihood of bank failures increases due to factors such as higher interest rates, increased risk of loan defaults, lost investments, large customer withdrawals, and tighter government regulations.
But even under stable economic conditions, banks may choose to freeze or close accounts for security or other reasons. Because of this, relying on a single bank account is never a safe option.
Businesses should spread their funds across two to four unaffiliated banks, preferably in different countries, closely monitoring the activity of each account. I would recommend keeping two checking accounts with enough cash to cover 2-3 months of expenses each, and a third account to invest excess cash in safe and liquid assets.
Those who find it difficult to manage more than three accounts should have at least two. One account can be designated for normal business operations such as payroll and supplier payments, while the other can be used to hold the remaining funds.
For startups with a balance sheet greater than $3 million, it is advisable to have a savings account with a reputable and stable A-level bank such as JPMorgan Chase & Co or Bank of America in the United States, Deutsche Bank or Crédit Agricole in Europe to open.
Consider buying Treasury bills (or T-bills), US government bonds issued in US dollars and with maturities ranging from one month to one year, which also have an annual yield of up to 5%. When a bank goes bankrupt, T-bills are not affected by the bank’s financial position as they are held independently of the bank’s finances.
A smart idea would be to create an investment plan that prioritizes capital preservation rather than just profit. Never hold your VCs’ money in cryptocurrency – it’s too risky.
Related: What is a cash management account?
Tip #2 – Research countries, not just banks
When choosing a bank for your startup, don’t just look at how safe it is. Think of other factors that could make it stable or unstable in a given country, especially if there have been periods when banks there went bust.
To find a bank in the right place, find out about the local rules and laws that control banks there. Assess the economic and political climate, including inflation rates, the level of interest rates charged by banks, and the stability of the currency and banks in that location.
Related: Choosing a Bank for Your Startup: Here are a few things to consider
Tip #3 – Find out about deposit insurance schemes offered by regulators and institutions
Different countries have their regulators that manage their financial systems. For example, the United States has the Federal Deposit Insurance Corporation and the United Kingdom has the Financial Services Compensation Scheme.
These regulators are designed to protect bank deposits to some extent by offering insurance in the event of a bank failure.
The USA FDIC insurance typically covers up to $250,000 per depositor per bank for individuals and businesses. However, certain financial companies may offer additional deposit insurance options.
After the collapse of the SVB, the US-based financial platform Brex elevated its FDIC business insurance limit to $2.25 million. Meanwhile, the neobank Mercury elevated Deposit protection for its customers up to $3 million.
Other ways to increase deposit insurance coverage include using Certificates of Deposit Accounts (CDARS), credit unions, or the MaxSafe program, which can increase FDIC coverage to $3.75 million.
The UK UK-based startups can get deposit insurance up to £85,000 per bank per depositor through the Financial Services Compensation Scheme (FSCS).
Private banks and building societies (a type of financial institution) offer deposit insurance above the FSCS limit by joining the FSCS Temporary high balance program (THBS). It can offer additional protection for deposits of up to £1 million for up to six months.
Europe. In the European Union (EU), all member countries must have a deposit guarantee scheme (DGS) to protect customers in case a bank goes bust. DGS typically offers coverage of up to €100,000 per depositor per bank. However, non-EU banks are not allowed to offer any deposit insurance for companies.
Some European countries – both EU and non-EU – have additional insurance options beyond the DGS. In Norway, deposits of up to 2 million kronor per depositor and bank are protected Bankenes Sikringsfond. In Germany, many private banks are members of the Association of German Banks offers Insurance protection for deposits up to €50 million.
Due to the lengthy process of opening an account with an A-level bank (6-18 months), many startups prefer e-money institutions like Wise, Stripe or PayPal instead. In this case, the account opening process is faster (a few weeks) and offers a more seamless customer experience. But financial regulators don’t usually protect the funds stored there.
Related: The collapsed Silicon Valley Bank finds a buyer
Tip #4 – Warm up banks
By developing a relationship with your bank, you can benefit from more personalized updates on the status of your accounts and investments. One way to strengthen this relationship is to set up an investment account and buy stocks or bonds through the bank.
To build a beneficial relationship with banks, you should consider entrusting them with the management of your funds. High Net Worth Individuals (HNWIs), who have at least $1 million in investable assets, are the primary source of income for banks through their money management services. In CEE, the average standard commission for investment management services is around 1-1.5%.
In my experience as an investor, startups that employ smart cash management strategies have an advantage over their peers when trying to raise funds.
Make a plan of how much money you will have/need for the coming month; check and update it every day. Track when you have to pay bills and when you receive money. Make sure you have a money transfer approval process in place to avoid fraud; try the”Four-eyes principle.”
If you anticipate financial difficulties, notify your leadership team and board of directors, and reserve a line of credit with one of your major banks to support the company’s operations for at least six months (but only use it if necessary).
Related: Beyond the Basics: 5 Surprising Qualities Investors Look for in a Successful Team
