Businesses often have to take recourse to Bridge financing when they fail to secure a large or long-term financing solution within time. Simply, a bridge loan is defined as a short-term loan that funds businesses for a tenure of 2 weeks to 3 years or until a long-term loan is not secured.
Bridge financing is the most common form of financing for start-up businesses that witness frequent roadblocks during their early years. There are times when a business does not receive the new cash infusion within the expected time, or lower sales might be impacting its cash position, which is when bridge financing comes to the rescue.
How does it work?
Most of the time, bridge notes are rendered in the form of convertible debt. This means that Venture Capital firms do not need the loan amount to be repaid in cash, but instead they want their debt converted into company’s stock on maturity. Such conversion is not attached to just principal or interest component but other additional clauses such as discounts, valuation caps or warrants.
What equity-kickers mean for financers?
- Warrants – A warrant gives the lender the right to purchase shares of the company at a specified price in the future. For example, a bridge loan of $1 million with 10% warrant coverage will give the right to the lender to buy $100,000 worth of stock at the next financing round’s prices at any time in future.
- Valuation Caps – Such a clause helps investors to prevent loss in their ownership due to unrecognized gains in the company’s value during the bridging period. For instance, a $1 million bridge loan with a $ 5 million valuation cap will promise the lender 20% of the company during the next financing round.
- Discount – As the name suggest, the discount clause promises the lender to buy shares at a discounted price during the future round of financing. This means that a 20% discount on a $1.20 million loan will entitle the lender to buy $1.50 million worth of shares in future.