Most start-ups don't take into account FX risk and currency volatility while raising capital from foreign investors.
However, FX risk affects every international transaction involving startups, from raising capital to international sales. Dealing with it inefficiently can lead to difficulties raising from foreign investors and excessive cross-border transaction fees.
In this article, we will help you understand where FX risk affects your startup, what you need to know in order to manage your FX exposure and finally, we will present you with the tools you need to manage FX risk in a simple and efficient way.
By doing so, you will have the ability to raise more money from foreign investors and lower hefty fees on international transactions, unlocking your startup's growth potential.
Where does FX risk affect my startup?
Put simply; FX risk is inherent in any transaction denominated in a currency outside of your functional currency that is exposed to time. For start-ups, here are some of the main focus areas, among others:
Source: SmartDraw
Raising capital in a foreign currency: If your start-up qualifies under this heading, this would likely be the first FX risk that you are exposed to. For instance, let’s say a Canadian start-up is raising funds from US investors in USD. How can they make those funds go further for them when taking the exchange rate into account? If the investment is incremental over time, how can they create certainty in forecasting the amount of CAD that they will end up with?
Foreign operating costs when expanding internationally: If your business is expanding internationally, chances are you will have fixed costs in that jurisdiction’s currency. If that currency were to appreciate over time, so too would your operating costs in that country. What if that currency appreciates so much that the cost outweighs the gain? If you are not yet generating enough revenue in that market to cover your operating costs, then the overall profitability of the business will take a hit.
International/cross-border sales: Selling into new markets can be a very exciting yet stressful venture. FX risk is something that is often overlooked by start-ups in this category simply due to the fact that their time is consumed by other seemingly more important tasks. However, since their pricing will likely be in that country’s functional currency, but their profits will usually be calculated in their reporting currency, depreciation in that currency could spell disaster for their profit margins, especially if they cannot be flexible on pricing.
Dividends in foreign currencies: While this is not seen nearly as much as the three other examples above, shareholders of a company that are located in other countries will also face FX risk as they will eventually want to convert their dividends into their local currencies.
How do I manage FX risk on my startup?
The main way of managing FX risk is through currency hedging. However, there are a lot of variables to keep in mind. Ultimately, the strategy around managing your FX risk is entirely up to how you can adjust to fluctuating currency rates on the fly. For instance:
Budget Rate: If you use one budgeted rate of exchange for the entire year in either your profit or cost centres (including dividends), it is a good idea to look at a hedging strategy that works to protect that yearly budget rate. In setting your budget rate, make sure you allow for enough of a buffer from the current spot rate so that you give yourself a realistic shot at attaining it.
Most businesses do not hedge their entire year at once as their forecasts are not often 100% accurate. Instead, what they do is dictate the approximate percentage that they would like to be hedged in order to reduce the amount of volatility they experience.
This percentage can range between 25% and 90% over a 12-month period, with the monthly percentages often cascading over time. Since these businesses are not hedging 100% of their exposures, it is extremely important for them to understand the rate they must achieve for their remaining forecasted exposure in order to come in at or better than their budget rate.
Flexible Pricing: If you are in an extremely competitive industry that requires that you quote based on the current rate of exchange, a proactive hedging strategy is not right for you. That being said, if you are offering payment terms to your customers, the time between when the sale is made, and payment is received is where the risk lies. Businesses that receive a payment within a week of sale generally do not look at hedging this exposure as long as they have buffered their reference rate. For wider terms, these businesses hedge all or part of this exposure as soon as the sale is made to lock in profitability.
What are the best FX risk management strategies?
There are several viable counterparties between banks and brokerages. Historically, banks will give start-ups very high FX spreads with a low level of service until their FX flows increase to the point that it warrants more attention from them. Brokerages, on the other hand, tend to give better upfront spreads, but since their dealers are paid commissions on trades, it is in their best interest to generate more revenue through trade types where the spreads are less transparent.
FX flows vs spreads by service providers.
Ultimately, the provider that is best for you will provide the following:
- Fair Spreads
- Competitive FX Credit Facility
- Contract Flexibility
- Up-to-date Reporting
- Online Platform
The most effective way for start-ups to handle this situation is to find a provider that allows you to quantify your investors' FX exposure, ensures low transaction costs and generates instant reports that can be shown to stakeholders.
Deaglo provides startups with all the tools they need to manage their FX exposures, allowing them to successfully raise more money from foreign investors and unleash their growth potential.