The short answer is yes, startups can have multiple closings in a round of funding. However, founders should carefully consider whether this approach is right for them.
In a round of startup funding, a “closing” refers to the process of finalizing an investment from one or multiple investors. This typically involves executing definitive investment documentation and transferring funds to the startup in exchange for an ownership stake in the company.
While the most standard round will have a single closing, in reality, this often doesn’t happen. In many cases, a majority of investors are ready to close, but a few stragglers aren’t. Instead of waiting for the slower investors, the startup and lead investors will often negotiate the option for additional closings.
Additional Closing Term
If additional closings are allowed, the term will typically include a few key points:
- Share Limitation. Generally speaking, investors have a target percentage ownership in the company. It’s not in their best interest for an unlimited number of shares to be issued in a second closing because it will dilute them and lower their stake in the company. The provision often provides a maximum number of shares that may be issued in subsequent closings.
- Time Limitation. All parties should eventually know that the round is closed, and the cap table is fixed. It’s common to set a final date when the additional closes must be completed. Typically, the date is 90, 120 or 180 days after the initial close.
- Approval Rights. Sometimes investors will want to approve new investors in additional closes. They may require that a majority of investors in the round approve the new investors, that the board of directors approve the new investors or both.
- Same Terms. Lastly, the new investors must come in on the same terms as the current investors. It’s in the company’s and investors’ interest to ensure that all investors in a round are on the same terms.
Advantages and Disadvantages of Multiple Closings
Multiple closings in a startup funding round offer several benefits to both the startup and investors, but there are also drawbacks.
The most practical advantage of multiple closings is that they allow startups to get money in the door while they are finalizing terms with slower investors. When the financial runway is getting short, this can be extremely helpful.
While there are benefits to multiple closings, there are also potential drawbacks that should be considered. One disadvantage is that they can create more administrative work for the startup and its investors. More administrative work also increases legal fees on the deal. Each closing requires legal documentation and additional due diligence, which can be time-consuming and costly.
Another potential drawback is that they can lead to uncertainty for both the startup and its investors. If a subsequent closing fails to attract enough investors, it may signal to others that the company is struggling, which could harm its reputation and make future fundraising efforts more difficult.
While multiple closings can provide benefits such as increased flexibility and strategic fundraising opportunities, they also come with potential drawbacks that should be carefully considered before deciding whether or not to pursue this approach.
Legal Considerations for Startups When Having Multiple Closings in a Funding Round
When structuring a funding round with multiple closings, startups must be aware of the legal considerations that come with this approach. Here are some key legal considerations to keep in mind:
- Securities Laws and Regulations. Startups must comply with securities laws and regulations when raising funds in multiple closings. Each closing will likely require an additional Securities and Exchange Commission (SEC) and state filing. Startups should work closely with legal counsel to ensure they are complying with securities laws and regulations. Of course, if you need legal counsel to help you figure out securities filings, feel free to reach out to us here.
- Due Diligence Requirements. Investors will conduct due diligence on the startup before committing funds in any round of fundraising. When raising funds in multiple closings, startups should be prepared for due diligence to occur at each closing. To streamline the due diligence process, startups should maintain organized records of all financials, contracts, intellectual property rights and other key documents. This can help demonstrate transparency and build trust among investors. If you want to learn more about the due diligence process, click here.
- Documentation Requirements. Each closing requires documentation such as stock purchase agreements, investor rights agreements and voting agreements. Startups should work closely with their legal counsel to ensure that these documents are drafted accurately, and reflect the terms negotiated between the company and its investors.
As always, if your startup is looking for legal counsel, shoot us an email or set up a free consult here.