Below is the “Tip of the Week” transcript from the Podcast Episode 12: Advising & Partnering with early-stage Startups (Glenn Gottfried)
We talked earlier about the rolling close or the cascading close. My assumption upon entering the industry was that all fundraises would utilize escrow, and a minimum amount of dollars would be required to trigger the round close and transfer the money over to the startup. However, to my surprise, there are a number of situations where this isn’t the case, and an escrow is not utilized. What this means is that startups are doing a “rolling” close during their fundraise… so while they may be raising a half million dollar round, they are collecting $10k, $50k, or $100k checks as they go… and many times it can take significantly longer to raise the money than expected. In other cases a startup will fail to raise the total amount and you’ll hear these comments like, “well we decided to do a smaller round and raise more through our Series A next year.”
As an investor, one must be careful not to become a bridge financier… unless of course bridge financing is your strategy. And what I mean by a bridge is that you are providing capital that bridges or allows the startup to continue fundraising on the hope that they close their round. This is often considered one of the more risky types of capital b/c on top of all the other risk factors associated with startups, you are now adding the risk of their ability to fill out the rest of the round. So, as Glenn mentioned earlier, if an investor can’t get escrow and is set on an investment, there should be a benefit to first money in. Often I’ve seen startups around here set a date by which the investors get a larger discount on the convertible note. So, if you get your money in by the end of next month, maybe you get a 25% discount instead of a 20% discount. If you aren’t sure what caps and discounts are for convertible notes, we will be covering this in next weeks episode… all about the convertible note, with Bill Payne. The real message here is that startups should create scarcity and incentives for investors to take action or pass. And as an investor, if you are not getting a benefit for first money in, then others likely aren’t either… and you may just be funding a bridge to nowhere.