From early-stage startups trying to make it to their Series A to late-stage companies gearing up to go public, bridge rounds are a common occurrence in the startup world. But what are the implications of a bridge round, and how do they work?

What is a Bridge Round?

A bridge round of financing is exactly what it sounds like – a small round of funding to tide a startup over until its next larger round of funding; for example, getting from a Seed round to Series A. Bridge rounds can be and are implemented throughout the life of a startup, from early to late stage.

Why Startups Use Bridge Rounds

Boiled down, startups use bridge rounds when they need more money. This can be due to various reasons, depending on where a startup is in its lifecycle. For an early-stage startup, a bridge round may be needed due to not raising enough in the previous round of funding or because revenue hasn’t grown as expected. For later stage companies, bridge rounds can be used to get companies where they want to be in order to go public. In such instances, bridge financing can aid in mergers and acquisitions, reaching certain milestone targets, covering the costs of going public, etc.

Another common reason startups may go after a bridge round is that they want to put off their next large round of financing until they have reached a higher valuation.

How Bridge Rounds Work

There are two routes a startup can take when it comes to bridge financing: debt or equity. Typically, startups prefer debt, while investors prefer equity.

What are Convertible Notes and How Do They Work?

Debt Financing

More often than not, bridge rounds are structured as a convertible debt.

Generally speaking, these notes are structured so that upon maturity (theoretically the next round of funding over a certain amount), the investor’s bridge note will convert into equity shares. Like a convertible note, bridge notes typically convert at a discount to the next round, and this percentage can vary. Valuation caps may also be added to a bridge note, which are intended to protect investors from unrecognized gains in the value of the startup during the bridge period.

Something startups should be wary of when pursuing debt financing during a bridge round is combining a discount with a high interest rate payable to the investor. It’s important to strike a balance between incentivizing the short-term investment (the bridge debt) without disincentivizing the long-term investment (Series A, for example).

Let’s assume a bridge investment of $50,000 in a note whose terms include a 30% discount and 8% simple interest per annum. Two years later, it’s time to start work on securing a Series A round, hypothetically priced at $1.00 per share. The holder of that $50,000 note would be entitled to $58,000 of equity at $0.70 per share – 82,857 shares. Put more simply, it’s best to structure the note in a way that dilution doesn’t become an issue later.

It’s also possible that the next round of funding – the qualifying event that converts the loan to equity – may never happen. If that does occur, it leaves both the startup and its investors in a bad situation.

Equity Financing

For a startup looking to avoid high interest rates on debt, they may go the equity route instead. Under this structure, the startup usually finds a venture capital firm to fund the bridge round in exchange for equity ownership in the startup. Naturally, startups tend to be more wary of this kind of financing because of the loss of control.

Equity Financing vs. Debt Financing: Which is Right for You?

Investor Perception

Naturally, investors may have some reservations about bridge rounds. While it’s certainly not always the case, bridge rounds may indicate to potential investors that there is trouble afoot. For current investors, a bridge could be positive, since it can offer a relatively small investment that has the potential to really pay off. Of course, there’s also the risk that the larger financing “right around the corner” doesn’t happen. As with all investments, tolerance for risk versus potential reward and a sound assessment of the company seeking bridge financing are key.

When done strategically and with careful consideration, bridge rounds can be the difference between failure and flourishing. If you’re interested in learning more about how you can raise funds for your startup, you can apply for an offering on MicroVentures.

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The information presented here is for general informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive offering documentation for any security, investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest, directly or indirectly, in any company. Investing in both early-stage and later-stage companies carries a high degree of risk. A loss of an investor’s entire investment is possible, and no profit may be realized. Investors should be aware that these types of investments are illiquid and should anticipate holding until an exit occurs.