Bridge financing demystified - the key to short-term funding

Bridge funding rounds, often referred to as 'bridge financing', play a crucial role in a company's lifecycle. It can provide the necessary capital to reach the next major milestone, whether it's the next equity round, an acquisition, or an IPO.

In this blog, we'll delve into the intricacies of bridge funding rounds, their importance, and how they operate as well as exploring industry practices.

What is bridge funding?

Bridge funding is a type of short-term financing used by companies to 'bridge' the gap between their current financial needs and their next round of equity financing or an exit event.

This type of funding is particularly useful for companies that are not yet ready or do not wish to commit to a full funding round. This can be for  various reasons, such as market conditions, timing, or strategic considerations.

Why opt for bridge financing?

Businesses may turn to bridge financing for several reasons:

• Avoiding down rounds: in an investor-friendly market, companies may face down-rounds that are too dilutive or punitive. Bridge financing can provide the necessary capital without the need to compromise on valuation.
• Extending runway: it allows companies to extend their financial runway to reach key milestones that can enhance their valuation in a subsequent funding round.
• Flexibility: bridge rounds offer more flexibility compared to traditional equity rounds and can be structured quickly to meet immediate financial needs.

Common instruments used in bridge financing

Several instruments are commonly used for bridge financing, each with its own set of characteristics:

• Convertible loan notes (CLNs): these debt instruments accrue interest and convert into equity at a future financing round, typically at a discount to the round price. They may include high interest rates and an equity kicker to compensate for the higher risk.
• Simple agreements for future equity (SAFEs): These are equity instruments that do not typically accrue interest and convert into equity upon a future financing event.
• Advance subscription agreements (ASAs): similar to SAFEs, ASAs allow investors to pay for equity in advance of a future pricing round, converting their investment into shares at a later date.

Key terms in bridge financing instruments

When structuring bridge financing, several key terms need to be negotiated:

• Conversion triggers: the events that trigger the conversion of the debt into equity, such as a future financing round, an exit event, or a set maturity date.
• Conversion discount: to incentivize investors, a discount is often offered on the conversion price associated with certain trigger events.
• Valuation cap: this sets a ceiling on the conversion price to provide a benefit to the investor for taking the additional risk of investing early.
• Interest rates: for CLNs, the interest rate is a negotiated term reflecting the risk level of the investment.
• Redemption rights: some instruments, like CLNs, may include redemption provisions allowing investors to demand repayment under certain circumstances.

The growing trend of bridge financing

Data shows a significant increase in the number of convertible debt financings, indicating a growing trend in the use of bridge funding rounds. This trend reflects the flexibility and utility of bridge financing in various market conditions.

Considerations for founders

Founders considering bridge financing should be aware of several important factors:

• Cost: bridge financing can be expensive due to higher interest rates and equity kickers. It's crucial to weigh the cost against the benefits of extending the company's runway and avoiding a down-round.
• Dilution: while bridge rounds can help avoid immediate dilution, founders should consider the potential dilutive effects once the debt converts into equity.
• Investor relations: maintaining transparent communication with existing investors is key, as they may be the ones providing the bridge funding.
• Legal and tax implications: founders should consult with legal and tax advisors to understand the implications of bridge financing, including any potential tax exposures.

In summary

Bridge funding rounds are a strategic financing option for companies looking to navigate short-term financial needs while setting the stage for future growth. By understanding the instruments available, the terms involved, and the market trends, founders can make informed decisions that align with their company's objectives and investor expectations. 

As with any financial decision, it's essential to consider the costs, benefits, and long-term implications for the business and its shareholders. With careful planning and execution, bridge financing can be a powerful tool to support a company's journey to its next significant milestone.