The credit crunch finally sorta hits Silicon Valley

Here's a fascinating little development. From Michael Arrington at TechCrunch:

Up to 20% of venture backed startups may have been convinced by their financial advisors to put much of their spare cash into something called Auction Rate Securities, on the promise of money market-like liquidity with better returns. Now, that money is frozen, and startups are scrambling to find a way to free up the cash.

...

Some big companies have been hit. Jet Blue, for example, had $611 million, or a 72% of its cash and investment securities, tied up in ARSs. But in an informal survey, twelve out of sixty venture backed startups had some amount of cash in these securities, too. Often without the knowledge of the venture capitalists who financed them. A venture capitalist says that he believes 5-10% of total invested cash is frozen.

...

Comerica has been mentioned in many of the calls I've had venture capitalists, who say that the bank advised their clients to invest in ARSs as safe alternatives to money market funds, with a higher rate of return. “We just had no idea this was even a risk at all,” said another VC.

I actually had something like this happen to me during the last recession. Mrs. CC and I had a little pile of money from selling our New York apartment when we moved to London in 2000, which we were planning to use as a down payment when we moved backed to the U.S. Some meddling financial adviser at Citi talked us into taking the cash out of the money market fund where we had it and putting it into some sort of bank loan fund with higher interest rates. I knew there had to be some kind of risk-return tradeoff, but I wasn't entirely clear in my head what the risk was. We found out what it was when we moved back to the U.S. in 2002 and wanted to free up the money: The net asset value had dropped, and we had to take a loss to get our cash back.

There are two big lessons here:

1) Liquidity matters.

2) Be very suspicious of a financial adviser who wants to move your cash into an investment that he/she says will deliver higher yields at no additional risk.