What Is Bridge Financing?
Bridge financing 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 bridge loan or equity investment.
Bridge financing is also used for initial public offerings (IPO) and may include an equity-for-capital exchange instead of a loan.
Key Takeaways
- Bridge financing is an interim financing option used to solidify a short-term position until a long-term financing option can be arranged.
- Bridge financing can take the form of debt or equity.
- Bridge loans are typically short-term in nature and involve high interest.
- Equity bridge financing requires giving up a stake in the company in exchange for financing.
- IPO bridge financing is used by companies going public. The financing covers the IPO costs and then is paid off when the company goes public.
How Bridge Financing Works
Bridge financing "bridges" the gap between the time when a company's money is set to run out and when it can expect to receive an infusion of funds later on. This type of financing is most normally used to fulfill a company's short-term working capital needs.
There are multiple ways that bridge financing can be arranged. Which option a firm or entity uses will depend on the options available to them. A company in a relatively solid position that needs a bit of short-term help may have more options than a company facing greater distress. Bridge financing options include debt, equity, and IPO bridge financing.
Types of Bridge Financing
Debt Bridge Financing
One option with bridge financing is for a company to take out a short-term, high-interest loan, known as a bridge loan. Companies who seek bridge financing through a bridge loan need to be careful, however, because the interest rates are sometimes so high that it can cause further financial struggles.
If, for example, a company is already approved for a $500,000 bank loan, but the loan is broken into tranches, with the first tranche set to come in six months, the company may seek a bridge loan. It can apply for a six-month short-term loan that gives it just enough money to survive until the first tranche hits the company's bank account.
Equity Bridge Financing
Sometimes companies do not want to incur debt with high interest. If this is the case, they can seek out venture capital firms to provide a bridge financing round and thus provide the company with capital until it can raise a larger round of equity financing (if desired).
In this scenario, the company may choose to offer the venture capital firm equity ownership in exchange for several months to a year's worth of financing. The venture capital firm will take such a deal if it believes the company will ultimately become profitable as this will see its stake in the company increase in value.
IPO Bridge Financing
Bridge financing, in investment banking terms, is a method of financing used by companies before their IPO. This type of bridge financing is designed to cover expenses associated with the IPO and is typically short-term in nature. Once the IPO is complete, the cash raised from the offering immediately pays off the loan liability.
These funds are usually supplied by the investment bank underwriting thenew issue. As payment, the company acquiring the bridge financing will give a number of shares to the underwriters at a discount on the issue price, which offsets the loan. This financing is, in essence, a forwarded payment for the future sale of the new issue.
Example of Bridge Financing
Bridge financing is quite common since there are always struggling companies. It can also be more prevalent in capital-intensive sectors. For example, the mining sector is filled with small players who often use bridge financing in order to develop a mine or to cover costs until they can issue more shares—a common way of raising funds in the sector.
Bridge financing is rarely straightforward, and will often include a number of provisions that help protect the entity providing the financing.
A mining company may secure $12 million in funding in order to develop a new mine which is expected to produce more profit than the loan amount. A venture capital firm may provide the funding but, because of the risks, charge 20% per year and require that the funds be paid back in one year.
Bridge financing can be an expensive way for a company to raise capital and isn't generally the preferred option to raise funds.
The term sheet of the loan may also include other provisions. These may include an increase in the interest rate if the loan is not repaid on time. It may increase to 25%, for example.
The venture capital firm may also implement a convertibility clause. This means that it can, if it wishes, convert a certain amount of the loan into equity at an agreed-upon stock price. For example, $4 million of the $12 million loan may be converted into equity at $5 per share at the discretion of the venture capital firm. The $5 price tag may be negotiated or it may simply be the price of the company's shares at the time the deal is struck.
Other terms may include mandatory and immediate repayment if the company gets additional funding that exceeds the outstanding balance of the loan.
What Are the Cons of Bridge Financing?
The biggest risk of bridge financing is digging into a deeper hole. These loans tend to come at a high cost and need to be paid back quickly. Equity bridge financing is often expensive, too, and can involve giving up shares at a big discount.
Can a Bridge Loan Be Paid off Early?
Most bridge loans don’t carry prepayment penalties, although it’s worth checking to be sure. The added flexibility of being able to pay off the loan ahead of schedule is a definite benefit. If an alternative, cheaper source of funding is secured, the loan can be paid off immediately, helping the borrower to potentially save on interest charges.
What Is the Main Advantage of Bridge Financing?
Bridge financing can give companies a much-needed short-term cash injection to temporarily cover the costs of running the business or get the wheels rolling on an important investment or project. If there’s no alternative or the payoff promises to be greater than the cost, it can be a worthwhile option to pursue.
The Bottom Line
Bridge financing offers a temporary injection of capital to keep an entity covered and able to meet its needs until it receives an infusion of cash or regular, long-term financing. These arrangements are short-term in nature, tend to be expensive, and are often used to cover things like short-term working capital needs and IPO expenses. Bridge financing can come in various forms including debt, which involves getting a bridge loan, and equity, which involves receiving cash in exchange for shares of ownership in the company.
