A Founder’s Guide To Preparing For Interest Cuts In 2024

It's no secret that the Federal Reserve is planning to cut interest rates in the new year (though no one knows for sure). On the one hand, it's a good thing as the cost of borrowing money will go down, on the other, it makes the yield earned in a treasury account also go down. It may not sound like much, but a 25bps cut can make a significant difference when the “n” is large enough. In this guide, we break down the correlation between interest rates, the cost of capital, and the yield earned in a treasury account, and we share practical tips to help you prepare for the upcoming interest rate cuts. Ready? Let’s dive in!

How we got here, and why the Fed is planning to cut interest rates in 2024

We’ve covered this topic in several other posts, here’s the short answer. From 2010-2021, interest rates were near zero, which made borrowing capital an attractive option. Startups drunk on cheap VC money, spent it as fast as they brought it in. In 2022, we hit the peak with the economy (and inflation) skyrocketing to levels unseen in decades. The Federal Reserve (the Fed) immediately pulled the e-break and prepared to go in reverse. They slowly started ratcheting up interest rates to curb inflation, making the “cost” of borrowing go up, thus removing excess liquidity from the market. After eleven such rate hikes, the Fed finally hit its target inflation rate of 2-3% annually.

With only a few weeks left in 2023, the Fed has made it clear that they intend to cut interest rates in 2024 by as much as 75bps. Why?

You can think of the Fed’s actions of raising and cutting rates, like rocking a boat. When they cut rates, the boat rocks to the left. When they raise rates, the boat rocks to the right. Unlike rocking a real boat, where you can identify and act in real-time to prevent the boat from tipping over, the “Economic boat” rocks back and forth very slowly. As such, the Fed cannot anticipate or act quickly. This often led to the Fed rocking the boat too much to one side and then changing course at the last second to prevent catastrophe.

Heading into 2024, the Fed has seen some early warning signs from the economy that it may be cooling faster than anticipated (leaning to the right). As such, the Fed has signaled to the market that they will be cutting rates (if necessary) to course correct and reach equilibrium (to keep the boat afloat).

How the Federal Reserve interest rates affect the cost of capital and Treasury Bill yields

Simply put, the higher the Fed Reserve rates, the higher the cost of capital (all things equal). This is because of the opportunity cost of receiving risk-free yield from the Federal Reserve versus lending the deposits to consumers, startups, and other small businesses.

The relationship between the yield paid out on Treasury bills and the headline Federal Reserve interest rate is not as straightforward. Several factors can influence T-Bill yields including the prevailing economic conditions, monetary policy, and perceived risk. That said, generally speaking, when interest rates rise, T-Bill yields also rise, and vice versa.

What actions to take before the interest rate cuts

As mentioned above, two things happen when interest rates come down – the cost of capital goes down and so does the yield on T-Bills. As such, there are a handful of actions to take to prepare for the cuts, we’ve outlined them below.

• Reevaluate Your Capital Allocation Strategy - The majority of startups we spoke with in 2023 allocated 50%+ of their capital in 1-3mo T-Bills to maximize their yield (in the inverted yield curve environment). Going into 2024, these same startups with >12 months of runway are locking in higher rates via six and twelve-month T-Bills.
• Get Books in Order & Build Relationships with Lenders - Even if you don’t plan to take on debt in 2024, consider getting your finances in order and building relationships with lenders so you’re ready for anything. As they say, when you fail to plan, you plan to fail.
• Adjust Financial Projections - Following the interest rate cuts, VCs will likely deploy more capital into startups, and subsequently more startups (and consumers) will be willing to purchase more products. As such, you should consider adjusting your financing projections by 5-10% to account for the increased demand resulting from the lower cost of capital. 
• Review Capital Expenditure Plans - On a similar note, a lower cost of capital means that it's more affordable to take on additional projects and purchase additional assets. If you thought about purchasing new equipment, technology, machinery, real estate…etc. in 2023, but didn’t pull the trigger because rates were too high, consider doing so when rates come down in 2024. Again, plan ahead by reviewing your Cap-Ex plans and adjusting them accordingly.

What actions to take after the interest rate cuts

After interest rates have come down, we suspect the yield curve will invert again, and resume its traditional path (with longer-term T-Bills yielding more than shorter-term T-Bills). We also suspect that the VCs that withheld capital from late ‘22 - end of ‘23, will once again deploy capital at velocities not seen since late ‘20 or early ‘21. If you took the actions mentioned above, then you’re prepared for whatever ultimately happens. If you didn’t get around to it, no worries, there is still time to act. Outlined below are some of the actions to consider taking once the interest rates drop.

• Refinance or Restructure Existing Debt - Startups that took on term loans and other high-interest-rate debt in 2023, should consider refinancing their debt to bring down their cost of capital. Startups that surpassed their ideal debt-equity ratio should consider pursuing a recapitalization to bring it more in line with their expectations.
• Raise Debt Financing - A lower cost of capital often makes debt financing more attractive to startups, particularly if they’re interested in need of new equipment or working capital. We’ve done the hard work of putting together guides on most of the common forms of debt financing so you know which is right for your startup: venture debt, unitranche debt, term loans, asset-backed loans, financing leases, operating leases, leveraged buyout financing, and securities-backed lines of credit.
• Invest in Longer-Duration Securities - If you didn’t lock in 6-12 month T-Bills at their peak yield, there’s still time to do so. Consider parking 30-40% of your excess cash in long-duration treasury bills to maximize your yield. For more information, check out this guide covering the importance of T-Bills in a startup’s treasury management strategy.
• Establish T-Bill Ladder - Along the same lines as the point above, startups that do not have a T-Bill ladder strategy should consider implementing one. If you’re wondering how to do that, check out this guide on structuring T-Bill ladders to balance returns with liquidity.

Wrap-Up - Preparing For Interest Rate Cuts in 2024

Given you’ve read through this guide, you’re already ten steps ahead of your peers—congrats! To prepare for the impending interest rate cuts, reevaluate your capital allocation strategy, get your finances in order, establish relationships with lenders, and review your Cap-Ex plans for the new year. Once rates have come down, raise additional debt capital or refinance any existing high-cost debt, establish a US Treasury Bill ladder, and park the majority of your idle cash in longer-duration securities. By taking the actions above, you can ensure your startup is set up for success no matter what happens in the economic (and funding) environment.

If you’re interested in exploring debt financing options or US Treasury Bills, we’d love to help—get in touch with us!