A week after Silicon Valley Bank collapsed, a group of venture capital firms wrote to the shell-shocked start-ups they had put their money in. It was time, they said, to talk about the “admittedly not-so-sexy” function of financial management.
Days of scrambling to account for their companies’ funds confronted a generation of founders with an uncomfortable fact: For all the effort they’d put into raising money, few had spent much time thinking about how to manage it them.
In some cases, the sums involved were significant: Roku, the video streaming company, had nearly half a billion dollars in SVB when the bank run began — a quarter of its funds.
Many others, it turned out, had concentrated all the funding on which their long-term growth plans and impending salary needs depended in just one or two banks, not taking into account that regulators would only insure the first $250,000 of it in case of trouble .
The “easy money regime of recent years” allowed relatively immature companies to amass unusually large amounts of cash that were “far in excess of what they needed,” noted the former chief risk officer of one of the largest U.S. banks, who asked not to be named.
“The problem here is that the cash seems so large to me relative to the size of the companies,” he said. “Traditionally, people would grow into it over time. Nobody would give a couple of hundred million dollars to a start-up with 20 people in it” before the VC-driven start-up boom.
“When the money is flowing, you pay less attention to it,” said David Koenig, whose DCRO Risk Governance Institute trains directors and managers in managing risk. It was not unusual for people who had been successful in growing new things to ignore traditional risks, he added: “Risk to them is something separate from what they do in their business.”
Founders exchanging notes at the South by Southwest festival in Texas last week admitted they received a quick education. “We got our MBA in corporate banking last weekend,” said Tyler Adams, co-founder of a 50-person start-up called CertifID: “We didn’t know what we didn’t know, and we all made different but similar mistakes.”
His fraud prevention business, which raised $12.5 million last May, deposited money with PacWest Bancorp and struggled Friday to move four months’ salary to a regional bank where it had had a little-used account, while opening an account with JPMorgan Chase.
The VCs, including General Catalyst, Greylock and Kleiner Perkins, advocated a similar strategy in their letter. Founders should consider having accounts at two or three banks, including one of the four largest in the United States, they said. Keep three to six months of cash in two core operating accounts, they advised, and invest any excess in “safe, liquid opportunities” to generate more income.
“Getting this right could be the difference between survival and an ‘extinction level event,'” the investors warned.
Kyle Doherty, managing director at General Catalyst, noted that banks like to “cross-sell” multiple products to each customer, increasing the risk of concentration, “but you don’t have to have all your money with them”.
William C Martin, founder of investment fund Raging Capital Management, argued that complacency was the biggest factor in start-ups mismanaging their cash.
“They could not imagine the possibility that something could go wrong because they had not experienced it. As a hedge fund in 2008, where we saw counterparties go bust, we had contingencies, but that didn’t exist here,” he said, calling it “pretty irresponsible” for a multibillion-dollar company or venture fund to have any plan for a banking crisis. “What does your CFO do?” he asked.
Doherty withdrew that idea. “Things move quickly in the early stages of a business: the focus is on making product and delivering it,” he said. “Sometimes people just got lazy, but it wasn’t an abdication of responsibility, it was that other things took priority and the risk was always pretty low.”
For Betsy Atkins, who has served on boards including Wynn Resorts, Gopuff and SL Green, SVB’s collapse is a “wake-up call . . . that we need to focus more on corporate risk management.” Just as boards had begun to scrutinize supply chain concentration during the pandemic, they would now take a harder look at how assets are allocated, she predicted.
Russ Porter, chief financial officer of the Institute of Management Accountants, a professional body, said companies needed to diversify their banking relationships and develop more sophisticated finance departments as they grew in complexity.
“It’s not best practice to only use one partner . . . to pay your bills and meet your paychecks. But I’m not in favor of atomizing banking,” he said.
For example, IMA itself has $50 million in annual revenue and five people in the finance department, one of whom spends two-thirds of his time on treasury functions. It has cash to cover a year’s expenses and three banks.
Many startups have taken advantage of the easy availability of private funding to delay rites of passage such as initial public offerings, which Koenig noted are often moments when founders are told to put more professional financial teams in place.
However, it can be difficult to find financial professionals who are attuned to today’s risks. “There is a lack of CFOs with experience in working in really challenging times. They have never had to deal with high inflation; they could have still been in college or just started their careers during the Great Financial Crisis,” Porter said. “The skill set required may change slightly, from a dynamic, growth-oriented CFO to a more balanced one who can manage and mitigate risks.”
There’s another pressing reason for startups to get more serious about financial management, Doherty said: the number of businesses switching banks has allowed fraudsters to impersonate legitimate counterparts by asking startups to transfer money to new accounts.
“We started getting emails from suppliers with wire instructions in them – ‘you need to update your payments and transfer to this account,'” Adams added: “In the coming weeks, we’re going to see a lot of scammers saying ‘hey, we can take advantage of’.”
Kris Bennatti, a former accountant and founder of Bedrock AI, a Y Combinator-backed Canadian start-up that sells a financial analysis tool, warned of the risk of overreacting.
“To suggest that we should have optimized our finances for bank failure is absurd to me. This was an extreme black swan event, not something we should have or could have foreseen.”
One idea floated on Twitter in the past week – by former Bank of England economist Dan Davies – would be for VC firms to go beyond offering advice to their investees to offer outsourced treasury functions.
Bennatti was not in favor. “Honestly, I don’t think this is a problem we need to solve and certainly not a service that VCs should be offering,” she said. “Letting a bunch of tech bros handle my money is so much worse than letting it hang out at RBC.”