Yield Built For This Moment

We’re now all well aware of the painful market conditions founders are operating in. After a year-long scramble of capital raises and cost cutting measures, we’re now heading into what most are calling a protracted recession. Like the last chapter, we’re still navigating uncertain waters, however, unlike the last, the funding tools previously available to founders to navigate that storm are even more limited. Startups are looking for new ways to stretch their cash, many are finding shelter in yield-bearing accounts, but this too may come at a risk, as not all high-yield instruments are created equal.

Setting the Stage

The Federal Reserve started combating inflation in ‘22 through a series of rate hikes, making capital more expensive. In response, VCs tightened the supply of capital, and warned their portfolio companies to brace for a tough recession. Founders first responded by cutting costs across the board, then looked to secure alternatives to venture capital like venture debt and revenue based financing (for more on this, check out the column Don published in Forbes in December).

Today the Fed announced another rate hike, confirming that despite early signs of slowing inflation, relief is still far off. Big banks are expecting a recession in 2023. Startups are now running lean, many having either gotten to default alive, or trimmed enough to stretch runway through this year and beyond. But have they done enough? And if not, what options do they have left?

Unlike large companies, most startups have little left to cut. The bulk of the early payroll reductions have already happened, teams have let go of their office leases, and cut their  discretionary spend. To make matters worse, growing revenue will be increasingly difficult this year, as companies trim non-mission-critical SaaS expenses, increasing churn.

As Don wrote in his Forbes column in late January, startup funding is scarce, with venture capital down 63% and venture debt becoming more expensive in Q4 2022. Bottom line: borrowing is out of reach for startups, and further cuts are detrimental to continued revenue growth. So what’s left? Treasuries.

Enter Treasury Management

The one silver lining of the Fed’s response to inflation: yield on government debt is at highs not seen since 2008. Normally, holding government debt generates very little value for its holders, and other investments offer much more appealing returns. But right now, that’s flipped: an expected recession means significant risk in traditional investments, while the current Fed monetary policy implies unusual returns on government debt.

All of a sudden, there is massive interest in Treasury bills, a historically low-yield (at least in my lifetime) but very safe asset class. Startups who had ignored this option for much of the past few years are knocking on the doors of banks asking for a safe place to park their cash while earning a return. Fintechs are noticing and are challenging the incumbents.

How do they generate yield?

Most fintechs generate yield by partnering with brokerage firms or asset managers and transferring their clients’ funds into a Sweep Account managed by the third party. These Sweep Accounts are primarily composed of safer investments such as Treasury Bills or Government Bonds – two of the easiest and safest ways to hold government debt.

“T Bills” are basically an IOU from the Treasury department to its holders. Holders buy a bond at a certain price, and are repaid that bond plus interest (known as “Coupon”) at maturity. Unlike longer term bonds, Treasury bills have a maturity of just a few weeks. By buying bills with varying maturities over time, these funds create a Treasury Bill “Ladder” program: on any given week, a portion of the bills mature and pay out the coupon, which is then used to pay yield to customers. These bills are backed by the US government, which has never defaulted on its debt payments, making them a safe, virtually guaranteed investment.

The case for when “guaranteed”, isn’t guaranteed afterall

“Unprecedented” was voted “word of the year” in 2020, and it’s an apt reminder that just because something hasn’t happened before, doesn’t mean it won’t. In January, Secretary of the Treasury Janet Yellen warned of dire consequences should Congress fail to raise the debt ceiling.

The Treasury department can’t issue debt above its congressionally set debt limit, known as the “Debt Ceiling”. When that limit is hit, the government can’t issue new bills. And if it can’t do that, it can’t generate more cash to pay the debts it owes. Every few years, debate rages over a vote to raise the debt ceiling as congress debates the Federal budget. In the end, the ceiling is always raised, because everyone understands the consequences of a government default on debt: it would crater the economy, wipe away trillions in bondholder value, and drive up the long term borrowing cost for the Federal Government. It could also mean the Treasury could stop paying the coupon on its T Bills.

So why the dire warning? Because it might actually happen. And if it does, it would mean all that startup money locked up in T Bill focused MMAs will not generate any returns. The debate around government debt and fiscal policy hasn’t been this complex in a very long time, and Congress has rarely ever been this divided, especially within its own factions. Just last month, it took 15 votes to elect House Speaker Kevin Mcarthy thanks to a game of political chicken inside the majority party. That hasn’t happened in 100 years, highlighting the current political background that is serving as a stage for the Fed’s continued inflation fight.

Bottom line: that money startup founders parked into Treasury Bills isn’t as safe as they might think.

What’s the alternative?

Even as political brinkmanship continues to play out, the Federal Reserve is continuing to ensure its obligations to Banks as it pursues its fight against inflation. Through its Overnight Repo Facility, the Fed rewards banks who decide to store cash with them directly. Banks that participate receive interest through what is known as the Secured Overnight Financing Rate (SOFR). By raising that rate, the Fed incentivizes banks to park more money there rather than lending it out to customers. Less money in circulation slows the economy and lowers inflation.

Since early 2022, the Fed has been doing just that. Banks are now earning meaningful returns directly from the Fed, even as Treasury Bill coupon payments are at risk. More importantly, some of those banks are choosing to give that yield back to win clients over rather than keeping the profit—that’s exactly what Arc is doing.

Enter Yield accounts

Yield is a high-yield business account that is available to all Arc Treasury customers.

Yield comes standard with 4.00% APY, same-day liquidity, and dedicated white-glove service. Returns are tracked in an intuitive dashboard, and preferred allocations between primary and yield accounts are easily adjusted. Most importantly, Treasury funds that are transferred into Yield settle instantly and remain FDIC insurance-eligible.

Yield customers benefit from the same banking essentials they have come to expect from Arc: instant deposits, free money movement, unlimited cards, and customizable spend controls. They can also tap into non-dilutive funding, Arc’s investor and partner network, and one-on-one virtual advisory services such as fundraising prep or GTM and product strategy.

You can learn more about Yield (now Reserve) and sign up for an account here.

Money transmission services provided by Stripe Payments Company. Banking services provided by Evolve Bank & Trust, Member FDIC. Arc Cards are issued by Celtic Bank and serviced by Stripe, Inc. and its affiliate Stripe Servicing, Inc.

Yield paid by Arc is subject to change over time based on prevailing market conditions. Today's yield offer reflects the Annual Percentage Yield (APY) paid by Arc to customers, where payments are completed on a monthly basis according to daily cash balances held in the Yield account over the prior calendar month.