By Eric Hall
I’ve been getting questions about company cash investments after the failure of Silicon Valley Bank and the recent problems of First Republic Bank and others. I thought this would be a good time to review the investment policy I have used with my clients for over 30 years. This policy has passed audit and board scrutiny and I’ve never lost money for my clients following these guidelines, not even a penny. The latter is especially important, since the first goal of any good investment policy is preservation of capital. The other goals of these guidelines, in order of priority, are providing liquidity, and maximizing returns, given the constraints of your company’s allowable investments.
My Model Investment Guidelines for companies include the following recommendations around investments and cash management:
Separation of Accounts
In addition to following the guidelines, it is imperative that companies maintain separate cash and investment accounts. Any investment account must be kept separate from your checking/DDA (demand deposit account) account. Investments should be held in your company’s name, in their own investment account at a brokerage or in a trust account that is separate from your bank. Investment accounts should be held in the company’s name; “street” name or bank name is totally unacceptable. If you use a money market account (MMA), you need to verify the assets they hold and their investment guidelines. Recall that the companies and VCs who lost money in their MMA holdings in the Great Recession were invested in MMA funds that allowed auction rate or asset-backed securities. Stay away from these types of investments! Auctions fail and these types of assets can become worthless.
Cash Account Safety
Please note that your cash is safe in FDIC insured accounts. Looking back as far as 1979, no depositors that I am aware of have lost their principal in a bank that was taken over by the FDIC. Warren Buffet recently stated that the FDIC will not allow any depositor in a US bank to lose their deposits. I totally agree with Warren! Your deposits are safe in the US banking system.
Note that a $250K banking limit (for FDIC insurance purposes) is window dressing for Board of Directors. This amount of insurance is not sufficient to insure the cash holdings of most companies. But it is also not practical to have multiple bank accounts to chase insurance coverage; you’d need 40 bank accounts to get enough insurance to cover $10 million of cash deposits. There are better ways to manage risk. I don’t know any CFO or Controller who wants to reconcile 40 bank accounts each quarter. Remember, no sitting politician wants their constituents to lose any deposits because that would cause problems at re-election time. Your deposits are safe.
Checking Account Limits
I usually do not like to keep large amounts of cash in my checking account and never in excess of $250K for more than 2-3 days. Your cash should be earning interest, not sitting idle. Any excess funds should only be there for a few days at the most. You can always move funds the same day or overnight to meet payment requirements, as long as you have provided liquidity outside of your DDA bank. Regarding payments, I recommend not using paper checks. I prefer to use ACH since ACH payments usually clear in 2 days or fewer. You also need to be mindful of bank holidays since that can extend the clearing time. The ideal structure is to have your Checking/Zero Balance Account (ZBA) pull needed funds directly from your MMA account to fund AP and payroll expenses. ZBAs automatically sweep funds to or from your DDA account based on a target balance that you set. After a little practice, you should be able to set a $100K or $200K target balance. For receipts, it is also a good idea to use a lock box that sweeps to your MMA instead of your checking/DDA account. This will save you a step and is much more secure. Do not let your bank sweep your deposits overnight into the Bank’s own MMA account. Your deposits are at risk any time they are not in your name.
Liquidity and Investment Management
Preserving liquidity, however, can be another issue when banks fail. You may have secure bank deposits, but you may not have access to them for days or weeks. That’s what we saw with the SVB and Signature Bank failures with CFOs panicking about having access to their investment funds to fund their payrolls. Maintaining the bulk of your cash in an investment account will provide security and liquidity, which are the two most important factors in cash management. My company had no issue funding payroll since all we had to do was wire funds from our investment account to our payroll provider.
The best source of liquidity is to invest in quality securities like Treasuries, government agencies, investment grade commercial paper of A-2/P-2 quality or better, and overnight bank repurchase agreements from investment grade banks. You’ll notice that CDs have been left off this list. CDs are not liquid and can be very costly to redeem before their maturity date. You can invest in negotiable CDs but the loss in yield makes them less attractive to other money market investments. You can invest in investment grade corporate bonds rated AA- or better with maturities not greater than 2 years since they trade like MM investments. Money market securities have maturities of 2 years or less and your loss is usually limited to a reduction in interest earned, not principal, if you have to redeem early.
I would recommend that you have a maximum maturity of 2 years for any investment and a maximum average maturity of 1 year for your total portfolio. I am not a fan of laddering investment maturities on a monthly basis. This is a strategy for underperformance when benchmarked against an actively managed portfolio that takes advantage of a shifting yield curve and maturities.
If you have more than $20 million, you might want to look at using an outside investment manager. A MM account or insured savings account (ISA) is a better alternative for balances of $20 million or less. Actively managing investments takes time that you may not have. Leave it to the professionals if you don’t have time. If you’re interested in gaining more knowledge about short term investing, I strongly recommend you read Marcia Stigum’s book “The Money Market.” It is the definitive tome!
Please do not invest your cash in auction rate or asset-backed securities. Many CFOs invested in these prior to the Great Recession chasing yield and lost a portion or all of their cash when the auctions didn’t occur, or the assets failed. Again, preservation of principal and liquidity are your goals for managing your cash investments.
Cash Management: Discipline Required
Good cash management is not complex. It does require effort and daily diligence. You do need to balance your accounts daily between book and bank balances. You also need to do a 13-week rolling cash forecast regardless of how much cash you have. The latter will provide you with all the information you need to manage liquidity. Be disciplined and stay on course.
Your company’s cash management and investment policy should also be reviewed and approved annually by your Audit Committee. And finally, you should also review investment performance quarterly with your Audit committee.
Our FLG partners are available to consult with you around implementing appropriate standards of practice and investment guidelines for cash and investment management.