After funding, surplus cash a headache for start-ups

Without the assistance of in-house treasury operations, early-stage firms usually turn to their investors for help to manage their funds

Photo: Mint

Capital Float, a start-up that lends to e-commerce merchants, raised $13 million from venture capital firms SAIF Partners and Sequoia Capital in February. The two-year-old company was suddenly flush with cash. Its founders were, however, at a loss about how to manage the funds that would be needed several months later.

Gaurav Hinduja and Sashank Rishyashriga, the founders, had a new problem to worry about amid the excitement of raising Capital Float’s largest round of funding. It had raised $4 million in the first round.

“In the four million round, there wasn’t much of a surplus to look deeply into treasury (management). But with $13 million, the treasury is huge and so now there is a lot more focus on managing the treasury,” said Hinduja.

The problem is not unique to Capital Float. As start-ups increasingly raise large amounts of capital and without the assistance of in-house treasury operations, unlike established companies, the early-stage firms usually turn to their investors for help to manage their funds. Often it’s the investors that hand-hold the founders in the initial stages by putting down guidelines for investment of the capital raised.

“Many early-stage companies don’t have CFOs (chief financial officers) and financial controllers and do not understand the nuances of such investments,” said Kushal Agarwal, chief financial officer of Aspada Investments, which was one of the funds that invested in Capital Float in its initial round of funding. Agarwal, for instance, helps the fund’s portfolio companies manage cash operations.

Investors sometimes point them to qualified advisors. Larger funds prefer to have portfolio companies appoint specialists.

“Start-ups in the early stage or Series A stage usually do not have the wherewithal in the finance department—either to make the investments or adhere to the investment guidelines set by VC (venture capital) investors or to have detailed reports generated to track these investments,” said George Mitra, chief executive officer of Avendus Wealth Management, which helps start-ups with managing their treasury operations.

Investors don’t want promoters to spend too much time managing funds and would rather have them focus on building the business, Mitra added.

“Usually, they require some assistance from external parties, except for companies which have very large treasuries,” said Mitra.

But where do these start-ups invest the surplus cash?

When it comes to investing the idle cash, both start-ups (inherently risky businesses) and VCs (who invest in these risky businesses) prefer to play it safe.

“The most important thing is to invest these funds into assets that are not risky at all. So no equities and no fancy structured products,” said Hinduja. Hinduja’s Capital Float works with three-four wealth managers to invest its cash.

Mitra of Avendus agrees.

“These funds are not meant for maximizing returns. They are meant for a specific use of the company, which can be either working capital requirement, supporting the cash burn or as part of an acquisition strategy,” said Mitra, adding that investors want them to look at optimizing returns rather than maximizing them.

Fixed deposits, liquid funds and debt mutual funds are the most preferred investment assets for start-ups wanting to park their surplus cash. Firms can expect yields of around 7-9% from these assets. A liquid mutual fund invests in money market instruments such as short-term papers, commercial papers and government bonds.

“If something is required in the next 30-60 days, we generally put that amount in liquid funds. And what is not required in the immediate two-three months, we put that in six month or 12 month fixed deposits (FDs),” said Sujayath Ali, co-founder and chief executive at Voonik, a fashion app. Voonik raised $5 million from Sequoia Capital and Seedfund in June.

Agarwal of Aspada says that currently FDs make perfect sense for start-ups to invest funds that will be needed several months later as interest rates are expected to fall.

“Another benefit of FDs is that the interest on FDs is tax-free for most start-ups as they are generally loss-making entities,” he added.

However, it is not that these assets are completely risk free.

On 4 September, The Indian Express reported that start-up Oyo Rooms, which had invested close to Rs.100 crore in two short-term funds of JPMorgan Chase and Co. in India, was considering legal action against the asset management firm after the redemptions from the fund were restricted.

“Some of the key risks associated with these assets are interest rate risk and diversification risk,” said Mitra. Longer-duration funds are more prone to changes in interest rates.

Diversification is also important.

“You do not want to be a large part of one particular fund,” he added.

Liquidity is another important factor for start-ups to keep in mind.

“A company might change its business plan and might need to withdraw a large sum of money for a big marketing campaign. In such a case one would like to have the option of withdrawing money at any point of time. Hence, investors don’t encourage assets with deep lock-ins,” said Agarwal.

Whether start-ups manage their cash in-house or through external advisers, and whether they invest in FDs, liquid funds or debt funds, the basic tenet remains the same.

“The idea is not to think about earning returns on the money. The moment you start to think on those lines, you will start taking risk on that capital,” said Mukul Singhal, principal at SAIF Partners.

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