While sometimes bridge rounds can suggest a startup is in financial trouble, that’s not always true. Bridge rounds (sometimes called bridge loans or extension rounds) can allow a high-performing startup to take advantage of rapid growth, or prepare for an initial public offering (IPO).
There’s one reason for a bridge round – a startup needs more cash. But typically, they need the cash for two basic reasons:
To hit milestones or support fast growth. Bridge rounds can also be used to help startups expand and accelerate their growth. Bridge rounds can give startups a little extra time to prove their business model before approaching investors for the next funding round.
Bridge rounds typically come from a company’s existing venture capital (VC) investors. If the VC investors have significant financial resources, the startup can go back to these investors for more money, but it’s typically a one-time deal. VCs get a lot of requests for their fund reserves, and they’re wary of putting more money into a startup that’s not performing well. So founders need to be very prepared to make a strong case for additional investment.
When a startup decides it needs a bridge round, they’ll call a board meeting to discuss how much funding the company needs and more importantly, why it needs the money. Is the company hot hitting their plan? Are they reaching milestones but need a little more time before another funding round? Or, as mentioned earlier, are they performing much better than expected and need to hire more staff or purchase equipment to meet demand? Does the startup need more funds to expand into new markets? Based on that discussion, the board may volunteer to provide a bridge round, or the startup’s founders and CEO can petition investors for a bridge round.
This is one reason that founders need to provide regular updates to their investors. If the investors have bene kept in the loop on the startup’s burn rate and runway, the bridge round will be less of a surprise to investors.
Again, a bridge round is not something that startups can do repeatedly, so it’s incredibly important to have and present a very defined plan to hit the necessary milestones and reach the next funding round. Kruze Consulting once worked with a founder whose VCs said the bridge round is a bridge, not a pier. These rounds are intended to help reach a defined destination. Founders that request bridge rounds need to make them count.
Once a startup has gotten approval for a bridge round, the funds will be issued as a convertible note or a SAFE note. Both types of notes are intended to convert into equity at a later date. SAFE notes are simpler and give investors the right to purchase equity based on a trigger event (like a funding round) while convertible notes are debi instruments that carry an interest rate and have a maturity date. Once the trigger event or maturity date is reached, the investors can convert the note into equity. Before approving a bridge loan, investors will have agreed on their pro-rata rights to protect their ownership percentage in the business.
Bridge rounds happen often, and many startups go through the process. Generally, a bridge round is appropriate for startups with strong growth potential, but that need some addition funding to get them over a hurdle, like providing a business model, finalizing a product, or reaching other goals. Founders need to remember that bridge rounds come with caveats, and could potentially dilute their ownership share. Founders also need to present a compelling case that the bridge round will lead to a successful outcome. And remember, like everything else in venture capital, bridge rounds are negotiable.
If you have questions about bridge rounds, venture capital financing, or startup fundraising, please contact us.