The following is from Ask The VC, where Brad Feld and Jason Mendelson of Foundry Group answer questions related to venture capital investment and startups:
Q: How do I do multiple closings on a single round work? In our case, we have an investor wishing to give us headstart, certainly I imagine not an uncommon case in friend and family scenarios, though here we'd have multiple rounds of angels, without kicking up the gears to flush out a full seed round with other investors before that money changes hands.
A (Brad): There are several ways to do this. Let's break it into two cases: #1: You are doing a convertible debt round. #2: You are doing an equity round.
#1: Convertible Debt: This is the easiest case. For a convertible debt round, you can keep it as simple as issuing a promissory note for each investor. This promissory note can contain any special conversion terms, including what happens on a qualified financing (including the definition of the qualified financing), what happens on a sale of the company, and what happens if the company fails. You can do as many closings as you want by simply issuing a separate promissory note for each investor.
#2: Equity Round: The best way to do multiple closings on an angel equity round is to raise the early money using the convertible debt approach above with an automatic conversion into a pre-negotiated equity financing once a certain amount of money is raised. Let's say you are planning to raise $500k and your early investor is willing to do $100k of it at a $1.5m pre-money valuation. You can negotiate the equity terms with this investor, issue a promissory note for $100k to get that money into the company, and then agree (contractually or not) to do the full round once you've lined up the $500k. You do run the risk that either (a) you can't raise the full $500k or (b) some of your later investors will want different terms. If you have a good relationship with the first investor(s) you can usually manage this by including them in the process. You can also put a "most favored nation" clause in the promissory note to adjust their conversion features to match whatever the financing ends up if it is more favorable to them than the terms the negotiated.
An alternative approach to #2 is to negotiate all the equity terms with the expectation that you'll have multiple closings on the equity round. Then, do a first closing with whatever investors are lined up and have a fixed length of time (typically 60 - 120 days) to raise more money on the same terms. Again, you should be conscious of the idea that you might have a new investor want better terms - since this is your early angel round, you should consider including a most favored nation clause so the investors that committed to you early get the same deal as later investors in the same round if the terms happen to change.
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