- Bridge rounds are interim financing rounds raised between larger funding rounds.
- Bridge rounds can imply that a startup is facing difficulties—although this is not always the case.
- Bridge rounds are typically structured as convertible debt.
When a startup needs additional capital between two rounds of financing, they might raise a “bridge financing round” (often abbreviated to just “bridge round”).
What is a bridge round? It’s an interim financing round intended to keep the company afloat until the next, larger financing round.
While bridge rounds often carry negative connotations—such as implying the company is in financial trouble—that is not always the case. Bridge rounds might also provide an interim cash infusion to capitalize on rapid growth or prepare for an IPO.
What Is Bridge Financing?
Bridge financing, often in the form of a bridge loan, is an interim financing option used by companies and other entities to solidify their short-term position until a long-term financing option can be arranged. Bridge financing normally comes from an investment bank or venture capital firm in the form of a loan or equity investment.
Bridge financing is also used for initial public offerings (IPO) or may include an equity-for-capital exchange instead of a loan.
Why Do Startups Use Bridge Rounds?
- Financial difficulties. The startup is not getting enough traction, and their cash is quickly running out. Without a bridge round, the startup will likely shut down (29% of startups fail because they run out of cash). This scenario is the reason bridge rounds often have negative connotations. While this scenario may arise from a sudden change in market conditions, it can also be due to poor decision-making or financial planning by the founders.
- To hit certain milestones or sustain accelerated growth. Sometimes, raising a bridge round allows the startup to hit certain milestones. Achieving these milestones could result in a nice valuation bump in the next priced round. The startup could also be experiencing higher-than-expected growth, and require more cash to sustain this pace. These are positive scenarios and should be an easy sell to investors. Large, late-stage companies also use bridge rounds to put together additional financing in preparation for an IPO.
- Time Extension: Startups may need more time to achieve critical milestones that make them more appealing to larger investors. A bridge round provides the runway needed to reach these goals.
- Market Volatility: Economic fluctuations or market uncertainties can disrupt funding plans. A bridge round can help startups weather these fluctuations until the market stabilises.
- Cash Flow Management: They offer a temporary infusion of funds to cover immediate operational expenses, ensuring continuity while preparing for a more substantial funding effort.
- Valuation Enhancement: If a startup’s valuation has not yet reached the desired level for a significant funding round, a bridge round can help it build value and attract higher valuations from investors in the future.
How Is A Bridge Round Structured?
Bridge round is typically structured as either convertible debt or equity. Convertible debt involves raising funds through a loan that can later be converted into equity during the upcoming funding round. This allows investors to lend money to the startup with the expectation of receiving equity at a predetermined valuation. Equity bridge rounds, on the other hand, involve direct investment by purchasing shares at a fixed valuation.
Here’s an example: Consider a scenario in which a tech startup secures seed funding to develop an innovative software application. However, during the development phase, the startup realises the need for additional features and testing before launching a more extensive funding campaign. To address this gap, the startup initiates such rounds by offering convertible notes to existing investors. These notes represent a future conversion into equity at a discounted rate when the larger funding round takes place, incentivising early investors to participate.
What To Consider While Raising A Bridge Financing Round
- Transparent Communication: Startups must maintain transparent and open communication with both existing and potential investors regarding the purpose and terms of the bridge round.
- Exit Strategy: Clear plans should be in place for how the bridge financing will transition into the larger funding round, ensuring a smooth process and alignment of interests.
- Terms And Valuation: Striking a balance between attractive terms for investors and maintaining fairness for both existing and future stakeholders is critical.
- Investor Relations: Establishing strong investor relations by providing updates and progress reports fosters trust and engagement.
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