When I raised capital for Kohort in the first half of this year, I first raised capital in the form of a convertible note, which is a loan that typically converts into equity in the next round of funding. (You can read more about convertible notes here: Convertible Debt: Delaying Valuation, Convertible Debt: Mandatory Conversion, Convertible Debt: Valuation.) Shortly after taking in the convertible note, I closed a larger equity round which included the capital from the note.
For both the convertible note and the equity round we had to decide whether to have all of our investors invest in one closing (at the same time) or over numerous closings (at different times). When investors invest at different times it’s called a “rolling close." The choice between the two closing structures is not always obvious or easy.
What’s attractive about a rolling close is that it enables the company to both 1) take in money as soon as the first investor is ready and 2) accommodate the timing constraints faced by other investors. Exogenous factors can prevent an investor from being ready to invest—capital can get locked up, people travel, etc.— which in some cases can prevent someone from participating in your round if you have a rigid single closing.
So why not always do a rolling close? They are, after all, with few exceptions more advantageous to entrepreneurs. The answer: they can scare some investors.
In a rolling close, investors typically sign their contracts when they are about to fund the company; investors will often officially sign their contracts at different times. Since investors are typically not obligated to invest until they have signed on the dotted line, early investors can get anxious about being the only players in the syndicate.
Here’s what they’re worried about: if one minority investor puts some capital into the company and everyone else chickens out, the early investors will be exposed to financing risk. In this scenario, financing risk is the risk that the company runs out of cash leaving them with the tough choice of 1) giving the company more money than originally intended in order to protect their initial investment or 2) watching their initial investment evaporate. Get out over their skis or lose everything—a pretty bad set of options. Of course, this is only a problem if the rest of the investors don’t materialize. But it is a risk.
To combat this concern, most convertible notes compensate investors with a discount (the ability to get more shares for the same investment) that increases until the round is closed.
There are no black or white rules for how to handle this—just a lot of gray. At the end of the day, putting a rolling close in place is more convenient for founders, but your ability to enforce it will be a function of investor sophistication and interest.