I twittered that yesterday and wanted to elaborate.  For a startup nothing is as important as watching cash and burn rate.  Until recently the only hard part of that was the burn.  But as some companies have found out not everything touted as “cash” by their investment advisors.

Some companies had part of their cash in so called auction-rate securities.  Fred wrote about his personal encounter with these.  These provided a great vehicle for the last 20 years or so because you could get in or out every week and yields were high and usually tax free because the issuers were municipalities.  Then one day a few weeks ago folks found they could not get out of their auction rate securities.  The reason was that the weekly auctions stopped clearing.  What most sellers of these had failed to adequately divlose wa that they we’re in fact providing the liqudity by buying or selling to make the auctions work.

Now one might think this could not happen if one chose something like a money market fund which everyone seems to equate with cash.  And one would be wrong. So far money market funds have been safe although there have been a few that had to be propped up by their backers as as to not “break the buck."  While we have had some relief following the near collapse of Bear Stearns, there is still plenty of uncertainty left and bad stuff could yet happen to money market funds, especially the ones that invest in VRDOs (PDF). Unlike auction rate securities, VRDOs have a put option that allows the holder to get rid of it.  But the catch is that the liquidity for this put option is provided mostly by large banks or brokerage firms AND is contingent on the credit insurers (another party to this) maintaining a certain rating.  So there are a number of ways in which VRDO holdings might become temporarily illiquid – which is bad when you are counting on this money to fund operations.

So what is one to do?  There is no reason to panic and avoid money market funds, but one should diversify ones cash holdings across a few different money market funds (different isuuers and different underlying holdings, i.e. some money market funds based on treasuries).  Some people are moving everything to treasuries in a flight to safety, but because everyone is doing it, treasury yields have been compressed down to virtually nothing.