What are the most common cash management strategies for Venture Capital?

Forecasting cash flow is like forecasting the weather. Be careful with your assumptions and believing your own predictions. Base your budget on the most conservative cash flow forecast you have. Most forecasts have a high, base, and low case. Try to budget on less than what your low case predicts. This will mitigate the unforeseen headwinds, delays, and other obstacles you don’t see coming.

At first, it seems easy to manage cash flow at a venture firm: you get your management fee every quarter, so revenue is predictable, and you mostly call capital for your various funds, so the money flow is quite simple. But when you start to get distribution, things get more tricky: you need a scalable way to send checks to your investors, you need to decide whether to reinvest some of the capital (instead of distributing it), so there's a lot of good business judgment required. Then when you reach the point when you are turning a profit on your funds, cash flow modeling is really necessary: you need to create waterfall models to understand who gets when, you need to account for taxes before you distribute carry. That's when you need a CFO.

Cashflow forecasting is one of the most critical and most agile statements to create these days thanks to the dynamic nature of the businesses and the ecosystem. But even getting it 70 to 75 percent closer to reality does the job. This could help in identifying a lot of pitfalls way ahead of time and how businesses can dodge these pitfalls. No VC likes emergency and unplanned follow-up capitalization calls and hence pre-empting cash flows becomes critical

It involves maintaining liquidity while maximizing returns and minimizing risks. VC firms typically allocate a portion of their funds to short-term, low-risk financial instruments, ensuring ready access to cash for new investments and operational expenses. They also practice reserve allocation, setting aside funds for follow-on investments in existing portfolio companies to support growth and protect their stakes. Diversification across sectors and stages of investment reduces risk and balances the portfolio. Effective cash flow forecasting and budgeting are crucial for anticipating future capital needs. Additionally, monitoring the burn rate of portfolio companies helps in timely interventions to prevent cash flow crises.

1. Short Term investing of excess cash in short-term low-risk instruments such as money market funds or shortterm government bonds

For a VC too cash is limited and hence they have to be really picky at every stage about their action. Be it deal selection, sector diversification or timing exits, a VC needs to be clear about how the money would move and impact the Internal Rate of Return (IRR). Optimization of cashflow would mean the VC doesnt miss out on an opportunity of a new investment and also exit businesses at right time

Any company still in its infancy, whether cash generative or not (yet), should have both a 13 week and a 12 months cash flow forecast. Ideally with an ability to reconcile those on a regular basis with their actual bank positions. Short term a company needs to have a clear idea of its inflows and outflows, so that it is able to manage properly its expenses but also can react quickly to any external shock - think COVID lockdowns for example ! - and be very sharp when it comes to the levers it can quickly pull. Long term there needs to be both a clear view on where funds are being allocated for the year to come, but also how realistically the company will be able to either become break even or generate more free cash flow.

The cash distribution policy coupled with investment strategy dictates the cash flow. And not the other way round. All my GPs/LPs are in sync whilst investing. Plus we have a forecast mentioned in PPM itself based on waterfall distribution and investment strategy. So we are aware of time lines of investments. This will allow us to reinvest and also distribute the returns / investments.

Cash flow strategy is mostly an outcome of the fund strategy. The vision and mandate shared with the LP/GPs is the basis on which cash is managed. An aggressive investment strategy would entail a large proportion of funds to be invested at all times wheres a conservative strategy requires idle funds to be there so that investment possible when more lucrative options are available.

n my mind, cash is much more than mere currency; it’s the lifeblood of economies, the driving force that propels markets forward. It’s an essential element in the machinery of commerce, powering transactions and facilitating trade on a global scale. Cash is the catalyst that transforms ideas into reality, fuels innovation, and enables businesses to grow and thrive. In the intricate dance of the financial world, it’s cash that sets the rhythm, influencing everything from small-scale purchases to large-scale investments. Its flow is vital, directing the course of economic activities, shaping opportunities, and often determining success in the ever-evolving landscape of business