Bridge Financing
/brɪdʒ ˈfaɪnænsɪŋ/
Bridge financing is temporary funding that helps startups maintain operations and momentum while securing their next major investment round, acting as a financial bridge between current needs and future funding.
Bridge financing is temporary funding that helps startups maintain operations and momentum while securing their next major investment round, acting as a financial bridge between current needs and future funding.
Bridge financing is a form of short-term funding that companies use to bridge the gap between immediate capital needs and a future financing event. This type of funding is particularly common in startup and growth company contexts where a business needs additional runway to reach specific milestones that will enhance its valuation in an upcoming equity financing round or other significant funding event.
When you secure bridge financing, you are essentially obtaining temporary capital to keep your business operational and growing while you work to close a larger, longer-term funding round. This funding can come from existing investors, new angel investors, or specialised bridge lenders who understand the startup ecosystem. The capital is typically structured as a convertible note or as equity, with terms that convert into shares during the next formal funding round.
The key characteristic of bridge financing is its short-term nature, often ranging from 3 to 12 months. It is designed to be a stopgap measure, providing just enough capital to reach the next significant milestone, such as product launch completion, key customer acquisition, or revenue targets that will position the company more favourably for the main funding round.
Unlike traditional business loans from banks, bridge financing is structured with the specific needs of growth companies in mind. Traditional loans typically require collateral, have fixed repayment schedules, and charge interest regardless of company performance. Bridge financing, in contrast, is often unsecured and converts into equity during the next funding round, aligning investor returns with the company's success.
Traditional lenders focus on historical financial performance and assets, making them hesitant to lend to pre-revenue or early-stage startups. Bridge financing providers, however, evaluate the company's potential, the strength of the founding team, and the likelihood of successfully closing the next funding round. This makes bridge financing accessible to companies that might not yet have the track record required for conventional bank lending.
Bridge financing terms vary significantly based on the investor and company circumstances, but they often include conversion discounts, valuation caps, and interest rates. A common structure is a convertible note with a 20-30% discount that converts into equity at the next funding round's valuation, rewarding bridge investors for their early support and risk-taking.
Some bridge financing arrangements include a valuation cap, which sets a maximum valuation at which the bridge investment will convert into equity. This protects bridge investors from excessive dilution if the company's valuation increases dramatically in the next round. Interest rates on bridge financing typically range from 5-8% per annum, though this interest often converts to equity rather than being paid in cash.
You should consider bridge financing when your company has demonstrated promising traction but needs additional capital to reach key milestones that will significantly increase your valuation in the next funding round. This might include completing product development, securing pilot customers, or hitting specific revenue targets that would justify a higher valuation.
Bridge financing becomes particularly relevant when your company's cash runway is running short but you have strong indications that a larger funding round is imminent. Perhaps you are in advanced discussions with venture capital firms, but the due diligence process will take several months. Bridge financing provides the capital needed to maintain operations and momentum during this critical period.
The primary advantage of bridge financing is that it provides immediate capital without forcing you to accept unfavourable terms in a down round. If market conditions are temporarily unfavourable or if your company needs more time to demonstrate growth, bridge financing allows you to continue operations and build value before pursuing a proper seed investment or Series A round.
Bridge financing also signals confidence to potential investors in your next funding round. When existing investors participate in a bridge round, it demonstrates their continued belief in the company's trajectory. This can make it easier to attract new investors, as they see that insiders are willing to provide additional capital.
The most significant risk of bridge financing is that it assumes your company will successfully close a larger funding round within the bridge period. If the expected funding round fails to materialise, you may face default on the bridge financing terms, potentially leading to punitive conversion terms or even loss of control if the bridge financing includes aggressive equity conversion provisions.
Another risk is dilution. While bridge financing is typically smaller than a full funding round, the conversion discounts and valuation caps can result in founders giving away more equity than anticipated. This is especially true if the bridge financing terms are stacked with multiple investors participating in different tranches with varying conversion terms.
Bridge financing can positively affect future fundraising by demonstrating that your company can secure funding even in challenging circumstances. It shows resilience and the ability to navigate financial constraints. However, it can also create complications if not structured properly, such as when bridge investors receive preferential terms that make it difficult to attract new investors in the next round.
When entering bridge financing discussions, it is crucial to consider how the terms will affect your cap table and future fundraising. Excessive discounts or aggressive valuation caps can make it challenging to achieve an up round valuation in the subsequent funding round, as new investors will need to account for the bridge financing conversion terms.
Yes, bridge financing typically converts into the same class of shares as the next equity financing round. This means that if your next round involves issuing preferred shares to venture capital investors, the bridge financing will usually convert into those same preferred shares at the agreed discount or valuation cap.
In some cases, bridge financing may convert into ordinary shares if the next funding round involves a different structure. The specific conversion mechanics should be clearly outlined in the bridge financing documentation, which is typically less complex than a full term sheet but still requires careful legal review.
When negotiating bridge financing terms, founders should pay particular attention to the conversion discount, valuation cap, interest rate, and maturity date. A reasonable discount (15-25%) rewards bridge investors for their early support without excessively diluting founders. The valuation cap should reflect a fair assessment of the company's current worth while allowing for growth before the next round.
You should also negotiate a reasonable maturity period that gives your company sufficient time to close the next funding round. Typical bridge financing periods range from 6 to 18 months, with extensions possible if both parties agree. Including provisions for what happens if the next funding round doesn't materialise is also crucial—these might include conversion at a predetermined valuation or repayment terms.
Bridge financing typically occurs at a valuation that reflects the company's current stage rather than its projected post-milestone valuation. This means bridge rounds often happen at a lower valuation than the anticipated next funding round, which is why conversion discounts and caps are used to compensate bridge investors for taking earlier risk.
However, successfully utilising bridge financing to reach key milestones can significantly increase your company's valuation for the subsequent funding round. By demonstrating growth, customer traction, or product development progress using bridge capital, you position your company for a stronger negotiating position and potentially an up round valuation in the next equity financing event.
