Minimum Close Requirement: Smart Safeguard or Founder Bottleneck?

The minimum close requirement is a crucial aspect of startup fundraising that founders should be aware of. This figure is the minimum amount the company needs to raise to reach its milestones over the next financial runway.

This explanation might seem like a simple enough calculation, but it typically involves many complex nuances. As the startup founder, you’ll estimate this number carefully after factoring in the capital you’ll need for the runway. Or, to keep the company operating for the next 12 to 24 months.

The minimum close requirement also features in the term sheet that interested investors may offer. Thus, it can influence the progress of the funding round and whether it culminates in a successful raise. Let’s do a deep dive into understanding how this minimum close number works.

Understanding What Minimum Close Requirement Is

The minimum close requirement is the specific threshold a startup must raise before its investors finalize the round. Investors need assurance that you have secured sufficient capital commitments before releasing funds.

This amount should cover the company’s operating expenses for the next 12 to 24 months. Or until it reaches specific pre-determined milestones. If you’re unable to demonstrate that you’ve secured the desired capital by a particular deadline, the funding program fails.

Investors are entitled to withdraw their commitment or renegotiate for more stringent terms and conditions. Alternatively, they may choose to cancel their commitment entirely. Situations like these can prove disastrous for the company, and it may have to look for alternative funding sources.

For instance, bridge loans, SAFEs, microfinance, or debt financing on unfavorable terms. Startups may also have to turn to solutions like repricing the funding round by lowering their valuation. Offering pro rata voting rights and other perks to incentivize investors is another option.

Depending on the runway they have available, startups can postpone fundraising until they build market credibility. Opting for a soft landing by looking for merger and acquisition (M&A) offers is the last resort.

This is why you’ll carefully calculate the minimum close requirement. It has to be achievable but also enough to keep the company operational. Most importantly, it has to make sense to the investors. This variable depends on several factors, including the business model, growth stage, and sector.

Why the Minimum Funding Threshold is Crucial

This threshold amount features as a critical clause as a “condition precedent” in terms sheets and financing agreements. Here’s why it’s crucial.

Protects Investors and Mitigates Their Risk

Most startups raise capital from multiple investors who commit to wiring the capital only after they meet the threshold. This strategy protects investors by ensuring the startup has raised sufficient capital to meet its milestones. It also offers clarity about the objectives it hopes to achieve.

It assures them that the company will not run out of cash immediately after their investment. Investors want the startup to use their capital responsibly and effectively to finance its operations. They do not want to waste the funds on an undercapitalized venture that will ultimately run up losses.

Ensures Adequate Capital to Run Operations

You’ll calculate the minimum close requirement by factoring in the projected expenses over the next 12 to 24 months. Or, the time frame before you anticipate raising the next funding round. You’ll estimate the required capital to achieve Key Performance Indicators (KPIs) and sustain the runway.

Achieving the next milestones is also a priority, and these could include developing the Minimum Viable Product (MVP). Other critical benchmarks include proving product-market fit and achieving a specific revenue target.

Miscalculating the baseline funding requirement means you’ll raise a partial round, leaving the company underfunded. And, at a higher risk of failure. Don’t forget that around 29% to over 38% of companies go out of business as they cannot raise adequate capital.

Builds Credibility and Signals Viability

Achieving the minimum close requirement demonstrates the startup’s ability to attract substantial investment, which is a great signal. Stakeholders, including partners, current and future investors, customers, and employees, are more confident about its future success.

Meeting the capital sufficiency threshold or getting oversubscribed attracts other investors to join in future funding rounds. It not only de-risks investor capital but also proves the company’s stability.

Frees Up Bandwidth from Fundraising Activities

Raising funding is a complex, time-consuming activity that takes away time and bandwidth from running the company. Raising adequate capital and building a cash buffer allows you to focus on scaling operations and executing the projected milestones.

You’ll divert attention to developing a business plan to utilize the capital you’ve raised efficiently and meet your objectives. Thus, you’ll ensure growth, profitability, and attractive returns for investors.

Helps Avoid Excessive Dilution

Raising adequate capital during the funding round ensures that investors meet their commitments under the agreed terms. At the same time, you’ll eliminate the need to raise additional capital anytime soon. Don’t overlook the fact that each round invariably results in dilution.

You’ll offer an ownership stake or shares in exchange for the capital new investors provide. Fewer funding rounds keep the cap table clean and uncluttered.

Keep in mind that storytelling is everything in fundraising. In this regard, for a winning pitch deck to help you here, take a look at the template created by Peter Thiel, Silicon Valley legend (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.

Remember to unlock the pitch deck template that founders worldwide are using to raise millions below.

Factors Influencing the Minimum Close Requirement Calculation

Several factors can influence how you calculate the minimum capital threshold. Keep in mind that it has to make sense to the investors who want assurance that you’ve raised adequate capital. And that the company can reach the next growth stage. Here’s what you’ll consider.

From the Founder’s Perspective

• Milestones and Runway: As mentioned earlier, the core objective is that the capital committed should provide an adequate financial runway. This runway can be 12 to 24 months, depending on your estimations of the next funding round. Don’t forget to factor in possible delays and changing market conditions that can influence successful fundraising.
• Monthly Burn Rate: You’ll conduct a detailed analysis of the operating expenses you expect to incur over the next runway. These expenses should include marketing, salaries, product development costs, rent, utilities, and more.
• Key Milestones: You’ll factor in the capital needed to achieve key milestones that will justify a higher valuation during the subsequent round. For instance, achieving a specific number of customers, revenue, or building a functional product prototype. These milestones should drive real value like, say, validating the business model.
• Use of Funds Plan: When calculating the minimum close requirement, you’ll develop a clear plan for how you intend to utilize the capital. For instance, hiring key talent, building a client base, or creating a marketing infrastructure. Each initiative should address a core hurdle the company faces in its growth trajectory.
• Contingency Fund: As your experienced fundraising consultant will advise, it’s always advisable to create a contingency fund from the capital you raise. This money will act as a buffer to secure the company against unexpected challenges. Set aside a 15% to 20% buffer to deal with unexpected market downturns and sluggish growth in revenue and sales.
• Expected Equity Dilution: Don’t forget to factor in the estimated equity you’ll give away for the capital. Most funding rounds involve around 17.5%, though this figure is up for negotiation.

From the Investors’ Perspective

• Growth Stage: Early-stage startups in the pre-seed and seed stages typically rely on projections and team credentials for their valuation. Accordingly, their minimum close requirement is low. However, later-stage companies in the series funding stages have proven traction and robust financials. Accordingly, their capital requirement thresholds are much higher.
• Comparable Companies: Investors are likely to consider the minimum close requirement that comparable companies may have expressed. These companies could be operating within the same sector or geographical location. Using these market-aligned benchmarks, investors calculate the minimum check sizes and equity they can expect.
• Market Size and Potential: The Total Addressable Market (TAM) plays a significant role in the minimum threshold. If the targeted market is large and scaling quickly, you can expect investors to estimate a higher capital close requirement. They see the potential for higher returns and are open to providing more capital.
• Strong Founding Team with a Proven Track Record: The team slide is a significant factor in investors’ minimum close calculations. A strong founding team with a proven track record of success will entice investors to provide more capital. They are more confident that the team can execute on the business plan with their investment, thus de-risking it.
• Competitive Landscape and IP: If the company has a distinct competitive advantage, you can expect a higher minimum close requirement. This edge can come from a unique value proposition (USP) or strong intellectual property, such as patents and proprietary technology. The higher the investor confidence, the higher the capital threshold.
• Legal and Financial Due Diligence: If the company successfully passes in-depth analysis and due diligence, that reassures investors. Thus, the close requirement will be higher.

 
As the company founder, you’ll align your company’s objectives with investor concerns and arrive at a reasonable figure.

Rolling Closes vs. Minimum Close Requirements

A minimum close requirement is part of the “conditions precedent” clause in the term sheet investors provide. This clause specifies the conditions the startup must meet before the investors finalize the transaction. Then, they’ll sign the agreement to make it legally binding.

The term sheet outlines these criteria to secure the interests of all parties to the agreement. It ensures that all obligations, including legal, financial, and operational ones, have been duly fulfilled before the funds are wired. For instance, covering any legal compliance issues.

Once all the formalities are complete, investors wire the funds or send checks as specified in the term sheet. All investors wire the funds at roughly the same time, and the company can start using them. An alternative to this traditional arrangement is the rolling close.

In the case of a rolling close, investors finalize the investment deal and wire the funds immediately. They need not wait for the company to achieve its minimum capital threshold. This option has many advantages for startup founders.

Advantages of Rolling Closes

• Startups can access the funds and begin using them even if only a few investors have committed.
• Valuation is not uniform across all investors in the same funding round. Each of them can value the company according to their internal criteria and offer the capital that makes sense to them.
• Startups eliminate the risk of running out of runway while one or two investors complete their due diligence and finalize investment decisions. Those who find the opportunity viable can invest instantly.
• The fundraising process is more streamlined and far less time-consuming.
• The rolling close model works well for venture capital firms that raise and deploy capital each quarter. They need not wait for a minimum close requirement to invest.

 
The rolling close model addresses the downsides of the minimum capital threshold and could be a preferred solution.

Disadvantages of Rolling Closes

At the same time, founders should be cautious about adopting the rolling close model rather than the minimum close requirement. Here’s why.

• Investors provide capital at different times according to their internal investment deadlines. This factor typically entails extensive and complex administrative management for founders receiving the funds. Issuing share certificates, handling agreements and other paperwork, and updating the company’s records and financials become more complicated.
• Startups always run the risk of remaining underfunded if not enough investors commit the required capital. It is impossible to predict the outcome of the funding round until the last investor provides funding.
• On their part, investors may be reluctant to back a company since the outcome of the funding round is unclear. The rolling close model typically involves uncertainty.

The Takeaway!

Is the minimum close requirement a smart safeguard or founder bottleneck? Is the rolling close model preferable? There is no definite answer, and both models have their own pros and cons. At the same time, setting the minimum capital threshold ensures clarity and direction.

Both — investors and founders — know precisely where they stand vis-à-vis the success of the funding round. Having a pre-determined threshold sets the tone for the current and future fundraising events.

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