When Should My Startup Raise a Bridge Round?

The good, the bad and the ugly of raising a bridge round

From justifying burn rates and understanding how much funding is needed, to maneuvering around investor sentiments and tracking funding milestones, startup founders need to juggle several factors at the meeting table to ensure they have sufficient cash runway to keep afloat. And even then, sometimes, the runway is short.

In the event that a startup finds itself out of funds, the company may have to raise what is known as a bridge round. Bridge rounds are raised mainly because often, the alternative is to go out of business. 29% of startups shut shop because they run out of cash, and raising a bridge round might help founders with business savvy to avoid becoming part of the statistic.

A bridge round is essentially rescue financing for startups in need of working capital (although that may not always be the case). Bridge funding is short-term, interim financing that acts as a ‘bridge’ between the startup’s current liquidity needs and its next funding round.

Startups can choose to raise bridge funding by way of venture debt or equity, depending on factors such as how much ownership they want to retain and what is their repayment outlook. Some may even raise both, such as Indian interior design platform HomeLane, which recently raised a third of its bridge funding in debt and the rest in venture equity.

Time for a bridge round yet?

Bridge rounds are different from seed funding, or a Series A or B, in the sense that they are meant to give the startup an interim injection. While mainstream funding rounds set different business targets for startups, the sole purpose of a bridge round is to get the company to its next financial event.

Ideally, startups should be raising enough funding to last for about two years until their next round. Sometimes, that does not happen, either due to internal misdirection or mismanagement of funds (such as Awok, which shut shop a year after raising US$30 million) or external factors such as market volatility, or both.

A startup’s next financial ‘event’ could be an exit, sale, or further funding, depending on the conditions under which startups raise bridge capital. Startups can also choose to raise bridge funding for that that extra bit of cash to help them hit their funding milestones.

Take for instance Dubai-based eyewear ecommerce company eyewa, who raised $2.5 million in a pre-Series B bridge round last month. The company aims to utilize the bridge funding to fuel its expansion in the Middle East and North Africa region.

Startups tend to do this because it hands them stronger chips to negotiate with investors in the next funding round, can work to put off such a round completely until the startup reaches a stronger valuation, and can help to avoid a down round (although bridge rounds can themselves be down rounds if the startup is in financial distress).

A third reason to raise bridge financing is when a startup is about to go public. This kind of funding is a textbook-style loan from an investment bank that will underwrite the new issue of shares, and is meant to cover the expenses of raising an IPO.

In all three cases, bridge financing usually takes place at a discount, either as a means to give investors an incentive for pledging money to the round, or to offset the loan in the case of an IPO.

Further, investors also usually prefer to be issued convertible notes in a bridge round. This is because convertible notes are a form of short-term debt convertible to equity at a future date. The fact that it is a form of debt means that bridge round investors will be paid on preference before other shareholders in the event that the company goes out of business.

On shaky ground

Bridge rounds are strongly associated with risks. A significant reason for this is that raising one begs the question of where all the company’s previously-raised money went.

Startups are expected to reach certain targets with each round of funding, based on which they can raise more funds. When a startup raises bridge capital, doubts are raised in investors’ minds about the ability of the startup’s C-suite to manage their money well. Investors will naturally want to find out if the answer is no, so they know when to pull the plug or even hire new managers.

In these cases, it helps the startup’s case immensely if existing investors return to finance the bridge round, signaling to the market that the company still holds investor confidence.

For instance, in U.S.-based pharma company Pharmapacks’s $40 million bridge round announced on September 3, the securities division of its existing backer, JP Morgan Chase Bank, acted as the sole placement agent in the financing, according to a statement by the company.

When the startup’s lead investor or its largest investors choose to tap out of the bridge round, what it projects to outsiders is that while these investors were previously impressed enough by the company to generously back it, they are now having second thoughts.

Further, in the event that founders feel pressed to call for a bridge round because their accounts have been emptied out, they will end up negotiating with investors on the back foot, and stand a strong chance to lose as owners of the company, even if the startup gains.

Raising bridge rounds can put startups in a sticky situation, and may even lead to burned bridges with current and future investors. New investors joining the company will want to know what developments led to the bridge round, and if they need to be wary.

The key to raising a bridge round is to demonstrate to investors that the company really needs the money, is capable of putting it to good use, and has a strong grasp on its financial management strategies.

In the event that investor sentiments do not reflect this, it could be a sign that the company has not been diligent with its fund management, and may be burning more cash than it should be – always a red flag for investors.

When raising a bridge round, remember to communicate a compelling and concrete story to investors, and be ready with hard facts to field questions on why your cash runway is short, how the company expects to put the bridge round to use, and most importantly, whether investors need to be concerned about the outlook on their returns.

Header image by Freepik

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