The Role of Fixed Income Securities in Startups' Treasury Management Strategy

As someone interested in treasury management, you may be looking for ways to diversify and grow your startup’s cash, while reducing risk. One option to consider is fixed-income securities. These securities generate a steady stream of returns and can be less volatile than stocks. In this article, we cover all the basics of fixed-income securities: what they are, how they work, and what types exist, then we dive into some of the benefits and drawbacks and finally, we cover the role of fixed-income securities in startups’ treasury management strategy—let’s dive in!

An overview of fixed-income securities

Fixed-income securities are investments that provide a fixed rate of return over a specified period of time. They are typically issued by governments, municipalities, corporations, or other organizations and can be purchased directly from the organization, through a brokerage, or on an exchange.

When startups invest in fixed-income securities, through direct purchase, they are effectively lending money to the issuer. When startups purchase fixed-income securities on an exchange, they are simply assuming the “lending responsibility” of the seller. In return for the “loan”, the issuer can either pay them interest on the investment until maturity or pay them the full face value (par value) for the security upon maturity. The amount of said interest (also sometimes called “coupon”), is typically determined by the prevailing market conditions, though it may be set by the issuer if the security is purchased directly from them (e.g. TreasuryDirect).

The most common types of fixed-income securities include Treasury bills, Treasury notes, Treasury bonds, municipal bonds, corporate bonds, and certificates of deposit.

• Treasury bills: also called “T-bills”, they are the shortest form of government-backed securities—maturing in less than one year. Startups purchase T-bills at a discount, and upon maturity receive their full face value. See more on treasury bills.
• Treasury notes: also called “T-notes”, they are intermediate-term government bonds—maturing in two - ten years. Startups purchase T-notes at face value ($1000) and receive fixed, semiannual interest (coupon) payments.
• Treasury bonds: also called “T-bond”, they are the longest form of government bonds—maturing in 30 years. Startups purchase T-bonds at face value ($10,000) and receive fixed, semiannual interest (coupon) payments.
• Municipal bonds: also called “Muni-bonds” they are issued by local state and city governments and mature in less than five years. Startups typically do not purchase Muni-bonds as they are not as liquid as other fixed-income securities.
• Corporate bonds: are medium-term debt securities that mature in three to ten years, may or may not pay interest, and do not come with voting rights or equity in the company. Startups typically do not purchase corporate bonds, as they are too risky.
• Certificate of Deposit: also called “CDs”, they are essentially illiquid savings accounts that come with up to $250,000 in FDIC coverage. Startups typically do not purchase CDs as they are completely illiquid, and they generate lower returns than t-bills or t-bonds. See more on FDIC Insurance.

Benefits, and drawbacks of fixed-income securities

There are several benefits and drawbacks related to fixed-income securities to consider before determining whether or not they’re the right fit for your excess cash.

Benefits:

• Generate predictable & recurring returns
• Less volatile compared to stocks and other securities
• Some are considered “risk-free” as they are backed by the U.S. Treasury
• Provide greater diversification than individual stocks
• Greater liquidity compared to other securities

Drawbacks:

• Prevailing economic conditions & monetary policy can significantly impact the principal value of the security (see interest rates and bond yield)
• Potential for principal erosion if the locked-in rate of return is less than the rate of inflation
• Generate lower returns compared to other securities and have minimal capital appreciation
• Some fixed-income securities “lock up” funds, which render them completely inaccessible until maturity or are accessible, but only through the payment of large fines

The role of fixed-income securities in startups’ treasury management strategy

The goal of any startup's treasury management strategy should be to minimize risks and maximize returns. As mentioned above, fixed-income securities can generate predictable and recurring returns, thus they are the perfect fit for startups with excess cash. Typically the type of fixed-income security that best fits the needs of startups is Treasury bills. Why?

Well, T-bills generate higher returns than savings and operating accounts, they are backed by the U.S. Treasury which makes them effectively “risk-free”, and they are highly liquid. Most of the startups we talk to don’t just buy a single 6, 9 or 12-month T-bill, rather they set up a T-bill ladder or they purchase a T-bill-focused ETF. What’s a T-bill ladder?

T-bill ladders are formed through the purchase of multiple T-bills with varying maturities (1-12 months). By ‘laddering’ the T-bills the startup can access liquidity when they need it, generate substantial returns each month, and mitigate the interest rate risk. Each month when the relevant T-bills mature, they either roll the returns & proceeds into the purchase of new T-bills or pull the funds into their operating accounts to satisfy their short-term working capital needs.

Check out these resources on T-bills ladders if you are interested in learning more:

• How To structure Tbill ladders to balance returns & liquidity
• How to maximize yield with a treasury bill ladder
• How to hedge the principal risk of Tbill ladders with credit default swaps
• The importance of T-Bills in a startup’s treasury management strategy

Key factors to consider when evaluating fixed-income investments & tips for investing in them

When evaluating potential fixed-income investments, there are several factors to consider. 

• The Stability of Your Startup & Liquidity: while some fixed-income securities are highly liquid, others are not at all. If your startup is burning tons of cash, or if your cash needs are extremely varied each month, fixed-income securities may not be the right fit for you. The last thing you want to have to happen is a cash-crunch, which forces the premature sale of the securities causing principal losses. 
• Your Startup’s Ability to Forecast & Maturity Dates: One of the most important exercises to complete before purchasing fixed-income securities, is a forecasting exercise. You’ll want to understand exactly what your cash needs are for the next three, six, and twelve months, and then structure the maturity dates of your investments to line up with those needs. In general, most startups should park >50% of their excess cash in T-bills that mature in under 6 months. Also, most startups shouldn’t consider any fixed-income securities with a maturity date of more than a year in the future, unless they are profitable.
• Interest Rates & Economic Environment: we wrote an entire post on this point, the TL;DR is that in periods of economic uncertainty or rising rate environments, startups should only be invested in fixed-income securities with maturity dates of less than six months. These securities are generally much more liquid and flexible, enabling startups to roll the proceeds into new securities that generate higher returns, thanks to the upswing in interest rates.

Onto the tips:

• Invest in fixed-income securities with a variety of maturity dates - by doing so, you’ll instantly minimize your interest rate risk, while generating predictable, recurring returns.
• Consider investing in bond funds (ETFs) rather than individual bonds or Tbills - Yes, you’ll generate a slightly lower return and you’ll pay a management fee, but you won’t have to deal with any of the headaches of setting up or managing the investment, and the invested capital will be much more liquid.
• Pay attention to fees & gross returns - Headline rates vary from bank to bank and broker to broker—they mean nothing. When comparing funds and fixed-income securities between providers, make sure to ask for the gross return to make an apples-apples comparison. 
• Consider Treasury Management - Rather than researching, purchasing, selling, and managing the fixed-income portfolio of your startup, consider leveraging a treasury management platform that puts it on autopilot for you.

Final thoughts on the role of fixed-income securities in startups’ treasury management strategy 

Fixed-income securities can be the perfect fit for startups’ treasury management strategy when structured properly. They generate predictable and recurring returns, they are less volatile compared to stocks and other securities, and some are even backed by the U.S. Treasury which makes them effectively “risk-free” when held to maturity. That said, they’re not the greatest fit for startups with limited forecasting abilities and cash reserves, those with incredibly lumpy cash flows, and those who are looking to make a quick return on their excess cash. Before purchasing any fixed-income securities make sure that you determine what your short-term cash needs are and your investment time horizon, and that you understand the mechanics behind each of the securities you are considering (liquidity, maturity date, return..etc.). Check out Platinum if you want to put your treasury management on autopilot and leverage fixed-income securities as part of your portfolio.