Startups often face many challenges, including navigating venture debt deals and choosing the right banking partners. The recent issues faced by Silicon Valley Bank (SVB) have only emphasized the need for startups to reevaluate their banking relationships and financial strategies. Here’s some best practices for finance leaders going forward:
Understand the terms of your venture debt
During the SVB bank run, leaders from companies with venture debt from SVB were concerned that withdrawing their funds might result in breaching loan agreements that mandated maintaining their cash reserves in the bank. Many venture debt loans require startups to make the bank their primary banking party and move all excess cash there as collateral as loan condition. This can make breaking away from such a bank difficult and costly, even when better options become available.
Startups and their CFOs should pay close attention to the terms of their loans and evaluate the long-term implications of these agreements. Everything is negotiable — If you foresee needing to break loan covenants, go back to the discussion table and renegotiate the terms in the new-world, such as a lower than 100% threshold on cash required to be held in the lending bank.
Diversify your banking partners
Storing all funds in smaller, regional banks could subject startups to increased risk and restricted services. To mitigate risks and ensure financial stability, startups should spread their accounts across different banks (across globally systemic banks, national banks, and regional banks). This may include having a treasury partner, a daily banking partner, a debt partner, and an FX trading partner. By having a diverse set of banking relationships, startups can more easily adapt to changes and ensure redundancy in their financial operations.
Choose the right banks
After SVB's collapse, the banking sector experienced a contagion effect, with over $95 billion in market value vanishing within two weeks. Credit Suisse needed to be rescued by UBS, while First Republic Bank, a regional San Francisco-based bank, saw a 90% drop in value. Regional bank stocks have faced significant pressure following a massive outflow of deposits, leading to the failure of Silicon Valley Bank and Signature Bank.
Many startups opened banks at larger banks, but experienced slower and more bureaucratic requirements. Setting up business accounts at larger banks may involve in-person branch visits, long waiting times, and extensive verification documents.
When evaluating potential banks, consider the bank fit and bank health:
- How well does the bank know your industry? Have they worked with startups before?
- Does the bank offer the services your company needs?
- What’s the bank approval process?
- Who will be your primary bank contact? What is their ability to advocate for you?
- Is the bank equipped to grow with your needs as your company scales?
- Does the bank charge fees for various services (i.e. wires, monthly fees)?
- Are bank deposits experiencing consistent growth?
- Does the bank’s loan-to-deposit ratio remain below 90%?
- Is the bank’s Tier 1 leverage ratio (the relationship between a banking organization's core capital and its total assets) greater than 8%?
- How does the bank fare in comparison to its direct competitors?
- Has the Federal Reserve implemented any corrective measures?
Be aware of FDIC limits and their implications
Running a business often requires maintaining balances well above the $250,000 FDIC insurance limits to meet operating needs. Startups need to understand the risks associated with larger balances and consider strategies for mitigating those risks, such as leveraging sweep accounts and other cash management strategies.
Neobanks such as Brex and Mercury can offer innovative solutions for startups, but they also come with risks. When evaluating neobanks, startups should consider some of the following factors:
- Fee structures: Different neobanks have different fee structures, so it's essential to evaluate the fees charged for various services.
- Integrations with accounting and financial tools: Integrations make it easy to manage your finances and track expenses, payments, invoicing, and more. Check if the neobank integrates with the accounting and financial tools your business currently uses or plans to use.
- Expense management capabilities: Evaluate the neobank's expense management capabilities, such as the ability to categorize expenses, generate reports, and integrate with accounting software. These features can help you keep track of operating expenses, reduce administrative work, and simplify tax filings.
- Potential to earn yield: Some neobanks offer higher interest rates on deposits, providing the opportunity to earn yield on idle funds. Evaluate the interest rates, account minimums, and other requirements to determine if it's a good option for your startup's cash management.
- Customer support: The quality and responsiveness of customer support is crucial when choosing a neobank for your startup. You'll want to ensure that you can easily reach customer support or an account manager when you have questions or need assistance.
Investigate your payroll provider's banking relationships
The risks can reach beyond your startup’s bank. The recent SVB fiasco highlighted the potential risks of using a payroll provider that banks with a single institution. Startups that did not directly bank with SVB found themselves in trouble when their payroll providers experienced delay issues due to their relationship with SVB. For example, the payroll funds of Rippling’s customers were stuck in SVB, affecting over 50,000 workers waiting for their paychecks. Luckily, Rippling had previously set up accounts with JPMorgan as a backup payment infrastructure, which allowed funds to go through. Rippling also chose to allocate $130 million of its own capital to finance its customers' payroll.
As a finance leader, it's crucial to understand how cash enters and leaves your company and the relationships and dependencies between your payroll provider and their banking partners.
The recent SVB issues have underscored the importance of startups carefully considering their banking relationships and financial strategies. While there’s no one size fits all answer, startups can take these steps to reduce financial risk and better ensure their long-term success.