Bridge Financing For Startups: Navigating The Gap Between Growth And Capital

Bridge financing for startups serves as short-term funding to cover any shortfalls in working capital. These loans ensure that the company operations continue as usual until the management can raise equity funding. Typically, bridge loans have short tenures lasting from six to 12 months.

However, as the owner, you can structure the terms and conditions per the company’s immediate cash needs. Leveraging bridge financing can be a practical solution since venture capital has been experiencing a downtrend. Statistics indicate a decline of 15% in 2024 from 2023.

Moreover, conventional fundraising approaches take time to initiate and process. You’ll have to sustain the company for the next three to six or even nine months until you have money in the bank. In this interim period, relying on a bridge loan could be the next practical solution.

How does bridge financing for startups work? What are the pros and cons and potential pitfalls to watch out for? Read ahead to find out in detail.

Understanding What are Bridge Loans

You can use bridge funding to cover cash flow gaps and meet current obligations. This money can keep the company running until you receive incoming cash from say, bills receivables. Or returns from company asset sales. The underlying feature of such loans is that they are always short-term.

Startups use the capital to carry them from one growth stage to the next. They aim to replace the loan with a long-term solution quickly. Bridge loans are also called alternative funding options, as opposed to equity funding, which translates into an ownership stake in the company.

However, investors offering bridge financing may also require ownership shares in exchange for the money. Depending on the size of the company, its growth stage, and creditworthiness in the market, you’ll approach different lenders.

These capital sources can include advances from existing investors, venture debt, revenue-based financing, and bank loans. Expect to pay a higher interest rate for the funds and offer some form of collateral. Investors may request inventory, IP assets, or other fixed assets as security.

Types of Short-Term Financing

Bridge financing is a broad term that includes different types of short-term funding. For instance:

• Bridge loans are available from traditional banking institutions and credit unions. You can also approach specific lenders that support startups with cash advances. These loans are called debt bridge financing.
• Offering equity and shares in exchange for capital is an option, but you’ll factor in the possible dilution. These loans are also called equity financing.
• Venture debt typically carries low interest rates and flexible repayment conditions.
• Issuing Convertible Notes is a good option. These notes will convert into equity shares when the company achieves certain milestones, like a pre-determined valuation cap.
• SAFEs have several advantages, including the fact that they don’t have a maturity date or carry interest. They are ideal if you prefer to avoid debt and get money in the bank quickly.

Bridge Financing for Startups Fills the Gap Between Funding Rounds – Here’s How

Bridge loans are an excellent solution for startups to cover their capital shortfalls in between equity funding rounds. Typically, the average time interval between a seed round and a series A round is 22 months. This interval can be 24 months from series A to series B.

As for the gap between series B and series C, it averages 27 months or more. Organizing each round is time-consuming, and getting cash in the bank involves several delays. Companies need supplementary funding to extend their runways until they are ready to raise the next round.

When evolving from one growth stage to the next, a fledgling company faces several challenges. Cash flows can be volatile, and marketing and customer acquisition efforts may not yield the expected results. Lack of operating capital can also limit the ability to maintain manufacturing and deliveries.

A young company struggling to grab its market share and reach cannot risk delays or falling sales. This inability will also impact its valuation when you’re ready to approach investors for the next funding round. This is where bridge financing for startups comes in.

Availability of Venture Capital is Not Consistent

Market conditions, macroeconomic cycles, and geopolitical factors can influence the availability of venture capital. In the last five years or so, the period following the pandemic saw a spurt in venture capital investments.

However, changing market sentiments have seen gunpowder waning in recent years. VCs are not only deploying less capital than before, but also have more stringent criteria during due diligence and valuations. For instance, Q4 of 2023 saw the sharpest fall in VC to $248.4B.

In such conditions, when venture capital is not readily available, you’ll have to tap alternative sources.

Keep in mind that storytelling is everything in fundraising. In this regard, for a winning pitch deck to help you here, take a look at the template created by Silicon Valley legend, Peter Thiel (see it here), which I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.

Remember to unlock the pitch deck template founders worldwide are using to raise millions below.

Bridging Cash Flows

Growing companies often experience negative cash flows because they need substantial funding. They need money to invest in fixed assets and inventory and run marketing campaigns to build a robust customer base. Without capital, creating supply chains and building a market presence is challenging.

Startups also need money to invest in R&D to maintain their hard-won edge over similar products. Steady cash flows translate into competitive pricing, essential for sustaining growth. All of these expenses are reliant on consistent cash flows.

It is crucial to have a positive burn rate where the company has higher incoming cash than its expenses. That’s how you’ll ensure that you have adequate finances to maintain operations. You’ll also estimate cash flows to ensure an adequate runway, ideally a few months.

Your runway, calculated in months, is the interval you have left before the company runs out of cash. This is the time within which you need to raise additional capital. Ideally, you’ll calculate the runway in terms of base along with best-case and worst-case scenarios to plan your needs.

At this point, you’ll raise an equity round by reaching out to existing investors. However, if you’re not ready to give up more equity, bridge financing for startups is a more practical option. Know that not just startups but more established corporations also raise bridge loans to cover cash shortfalls.

Typical Uses of Bridge Loans

Startups and companies of all sizes and growth stages raise capital for different purposes. The main objective is to ensure they meet their milestones and improve valuation on schedule.

• Managing day-to-day operational expenses such as making payroll and rent
• Managing startup expenses before the product is ready for sale
• Covering advertising and marketing expenses to promote sales
• Developing the product for release into the market
• Accelerating the development of additional features to enhance the Minimum Viable Product
• Managing short-term debts
• Covering unexpected market downturns
• Purchasing inventory to quickly manufacture products and keep up with a surge in demand or one-off orders
• Covering expenses while waiting to collect bills receivables and outstanding invoices
• Expanding operational capacity by purchasing new equipment and machinery
• Purchasing or renting commercial properties to increase manufacturing potential
• Upgrading existing equipment and real estate for improved functionality
• Acquiring strategic companies with the objective of using their revenues to cover the bridge loan
• Investing in talent, inventory, equipment, or other inputs to grab disruptive market opportunities
• Upgrading and renovating commercial properties so they are suitable for mortgage financing
• Covering expenses related to an IPO, also called IPO bridge financing

When Not to Raise a Bridge Round

On the flip side, bridge financing for startups is not always advisable. For example, you anticipate problems with cash flows and want to raise money to remain up and running. Before diving into a bridge loan, it’s advisable to do a thorough analysis to evaluate the gaps.

Next, you’ll develop a game plan for using the capital efficiently and the areas that need improvement. Also, work out the specific milestones and timelines you hope to achieve with the money. The metrics resulting from the analysis should determine the amount you need to raise. And, if you need it.

The benefits should outweigh the collateral and interest you’ll pay. Also, remember that bridge loans are a solution only for stable companies with growth potential. A distressed company edging toward bankruptcy is not a good candidate, even if it gets board approval.

Bridge loans typically come with preferred liquidation rights, and lenders will expect to be paid off first. This factor places the company’s owners and shareholders at a disadvantage. Lenders backing a struggling company may also demand high interest rates and unfavorable terms to hedge their risk.

Regardless of your funding round size, you should know how to present the amount to raise in a pitch deck. If you’re looking for more information, check out this video I have created. Learn how to convey use of funds and other information.

How to Get Bridge Financing for Startups

Having identified the core objectives why you need funding, you’ll follow a step-by-step plan to get funding. Here’s how:

Analyze Your Needs and Payment Capability

As explained in the foregoing sections, you should assess how much funding you need to meet the company’s operational needs. Side-by-side, you must also work out how to cover the monthly payments. For instance, add up the accounts receivables and other expected total revenues.

Next, factor in the expenses you’ll make from the cash inflow and loan. Be absolutely confident about your repayment capability.

Explore Different Capital Sources and the Costs

Scout around the market and different types of lenders offering bridge financing for startups. Compare the loan amounts they offer, interest rates, payment terms, and other conditions. Make sure the loan product aligns with your business goals.

Don’t forget to factor in the collateral required and if you’ll have to offer equity in exchange for the capital.

Evaluate Lender’s Criteria

Before choosing the right lender, you’ll assess them as a good fit for your company. Remember that lenders have their specific criteria for evaluating companies to lend to. Here’s what you need to do.

• Make sure the lender has adequate funding to offer the company.
• Check for the collateral lenders will accept for the capital. They may offer loans against real estate, inventory, business equipment, savings account balances, or accounts receivable. Depending on the type of lender, they may require equity. Before agreeing to the terms, be aware that the loan amount is typically significantly lower than the collateral’s value.
• Lenders will evaluate the company as a viable investment. Expect to demonstrate that the company has robust financial health and has the potential to generate revenues. You’ll provide bank statements, tax returns, and cash flow statements. Loan makers may want a debt-to-income ratio (DTI) of up to 50% before approving the application.
• Undoubtedly, the company’s credit score is a criterion. However, lenders will likely focus more on its valuation and the collateral you’re offering.
• The company’s debt-service coverage ratio is also a consideration. Lenders will want to assess your ability to manage debt successfully. They may examine the owner’s and company’s credit profiles.

Work Out the Exit Strategy

When applying for bridge financing for startups, you must have an exit plan ready. This is the strategy you have in place for repaying the loan and is included in the business plan. Lenders will want to assess when and how you’ll repay the loan. Your exit strategy will depend on the use of funds.

For instance, you take out a bridge loan to upgrade and renovate the manufacturing facility to increase production capacity. Accordingly, your exit plan will involve producing and selling a given number of units and repaying the loan using revenues.

Or, paying the loan from the fresh injection of capital you’ll raise six months down the line. A well-defined exit plan serves to reassure lenders that their investment is secure.

Review the Terms and Conditions

Once the lender approves the bridge loan application, you’ll receive documents outlining the terms and conditions. The documents will include details like interest rates, repayment deadlines, overhead charges, and other fees. At this point, you can negotiate for better terms.

Sign and Complete the Loan Process

Once the bridge finance is finalized, you’ll sign the documents and receive funds in your company’s checking account. You can now continue operating the company until the next funding round.

Bridge financing for startups is an excellent solution to cover any short-term cash flow hurdles you face. They are valuable options as long as you structure the loan strategically and align it efficiently with your business goals.

Do your research and understand everything you need to know before diving in.

You may find our free library of business templates interesting as well. There, you will find every template you need when building and scaling your business completely for free. See it here.