As a Senior Financial Analyst at High Alpha, I help our new founders navigate the choppy waters that is fundraising for their early-stage startup.
Fundraising from venture capital investors is a critical step for our new businesses, but, for many first-time founders, this can be a daunting task.
I’ve observed a handful of topics come up while closing a funding round that many founders have not experienced and likely never considered. Whether triggered by investor timelines or the need for a startup to have cash in the bank, one of these topics is a “second close.”
What Is a Second Close?
When a founder closes an initial round of funding, investors sign final documents and cash gets wired to the company’s account. When an investor can’t wire the money by the time of the first close, a second close occurs where additional cash gets wired to the account at a later date.
While a second close isn’t necessarily a good or bad thing, situations that may trigger a second closing include:
- An investor has interest in participating in the round, but the investor has not approved a final decision prior to the first close. This can occur if the investor has a longer internal approval process than other investors participating in the round.
- Investors have not yet committed to funding the full amount the company is raising.
- The investor has depleted the funds available by making prior investments and must make a capital call to its Limited Partners to invest in your company.
- The investor has exhausted their current fund and is in the process of closing the next fund. In this case, the investor may ask to be part of a second closing once they can invest from the new fund.
If any of the above situations occur, a second closing may be necessary to fund the full amount of the round. In these scenarios, the company and some investors agree on terms and wire funds during the first closing. Then, the investor or group of investors involved in the second close will invest with the same terms and wire funds at a later date. A second closing typically occurs within 60 to 90 days of the first closing.
If investors have asked your company for a second close or you think one may be necessary to raise the full amount you are seeking, consider the points below to help determine how this will affect your company.
1. Is the Round Fully Subscribed?
When your zero-cash (or cash-out) date is rapidly approaching, time is of the essence. From the time a term sheet is presented it typically takes four to six weeks for cash to be wired to your account. This can be a tricky situation to navigate if you haven’t received commitments from investors to fund the entire amount of the round you are seeking.
A second close can be a good option in this case as your company will get cash in the door to keep the lights on during the first close from committed investors while giving you the time to continue the fundraising process with investors that haven’t committed yet.
2. Does Your Company Need the Cash?
If an investor prompts a second close because they are unable to meet the timeline of the first close for the reasons mentioned above, consider how badly your company needs the additional funds. Is the amount of cash they would be contributing a small portion of the round that is not a necessity, or is it a must-have to help your company achieve its next product or traction milestone?
3. Is This an Investor That You Want on the Cap Table?
As mentioned above, venture capital investors may have timing constraints that will not allow them to meet the timeline of the first close. If the investor is requesting a second close, consider whether this is someone that you would like to go on a 10+ year journey with while building your company. Does their experience, expertise, personality, and network lend itself well to helping your company grow? Remember that not all cash is the same. If the investor would be an effective long-term partner, a second close to add them to the cap table can be a good decision.
4. Are Other Investors Opposed to a Second Close?
If you are to the point where you are considering a second close, that means there is a first close with investors that may have an opinion on the matter. In some cases, investors involved in the first close believe that a second close gives other investors more time to evaluate the company offering an unfair advantage and, potentially, time to back out of the deal. Conversely, investors in the second close may be investing at a discount if the company gains significant traction between the term sheet and second close.
5. Are the Legal Fees Associated with the Second Close Worth It?
It is no secret that venture capital financing comes with the significant legal costs associated with drafting the required documents. As you can imagine, lawyers will bill even more for a round of financing with a second close. Based on High Alpha’s experience, a second close increases the legal fees associated with a financing round between 5% and 10%. Most of the legal documents will be drafted during the first close and will leave the final financing amount undetermined until the second close amount is finalized, but don’t be surprised when attorneys send a second invoice.
In short, a second close is a relatively common occurrence during the fundraising process and the factors above should help you determine whether a second close makes sense for your company. Any lawyer experienced in venture capital financing will be able to guide you through the process and make sure your company checks the proper boxes.
