Running a Venture Capital Fund

What is a Bridge Round?

Bridge rounds help startups “bridge” the gap between larger funding rounds. While not always ideal, they can be necessary to keep the company afloat.
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  • Bridge rounds are interim financing rounds raised between larger funding rounds.
  • Bridge rounds can imply that a startup is facing difficulties—although this is not always the case.
  • Bridge rounds are typically structured as convertible debt.

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When a startup needs additional capital between two rounds of financing, they might raise a “bridge financing round” (often abbreviated to just “bridge round”). 

What is a bridge round? It’s an interim financing round intended to keep the company afloat until the next, larger financing round. 

While bridge rounds often carry negative connotations—such as implying the company is in financial trouble—that is not always the case. Bridge rounds might also provide an interim cash infusion to capitalize on rapid growth or prepare for an IPO.

In this guide, we’ll cover why startups use bridge rounds, how bridge rounds work, and key considerations when structuring a bridge round. We’ll end with some considerations for investors when deciding whether or not to fund a bridge round.

Why Do Startups Use Bridge Rounds?

Every startup raises a bridge round for one reason: it needs additional cash. But there are different reasons they may need cash, each with very different implications.

  1. Financial difficulties. The startup is not getting enough traction, and their cash is quickly running out. Without a bridge round, the startup will likely shut down (29% of startups fail because they run out of cash). This scenario is the reason bridge rounds often have negative connotations. While this scenario may arise from a sudden change in market conditions, it can also be due to poor decision-making or financial planning by the founders.
  2. To hit certain milestones or sustain accelerated growth. Sometimes, raising a bridge round allows the startup to hit certain milestones. Achieving these milestones could result in a nice valuation bump in the next priced round. The startup could also be experiencing higher-than-expected growth, and require more cash to sustain this pace. These are positive scenarios and should be an easy sell to investors. Large, late-stage companies also use bridge rounds to put together additional financing in preparation for an IPO. This is what Robinhood did with a $1B bridge round in January 2021 before its IPO six months later.

How Do You Structure a Bridge Round?

Startups will first target existing investors during the bridge round and raise from new investors if additional funding is needed. Bridge rounds are often structured as convertible debt, as each party wants to optimize for speed. However, founders can use preferred shares for bridge rounds as well. In edge cases, a combination of both debt and equity can be used—although this is rare for early-stage startups.  

If the parties use convertible debt for the bridge round, they'll set either a valuation cap or discount rate to the next priced equity round. They'll likely set the valuation cap to the post-money valuation of the previous priced round (to learn more about how debt financing works, read our guide to convertible notes). 

If the parties choose to use preferred shares instead, the bridge round will likely track the terms of the last priced round. This is especially the case if the bridge round investors are the same as those from the previous priced equity round.

An important caveat: like everything else in venture investing, bridge rounds are negotiable. For instance, in a scenario where the startup is facing financial difficulties, investors may negotiate to invest at a  valuation that’s lower than that of the previous round.

A Bridge Round Example

Imagine a startup raised $5M in a Series A one year ago at a $10M post-money valuation. They now want to raise a $2M bridge round to hit certain growth milestones before raising a Series B—planned another year from now.

Assume the $2M bridge round goes as planned and the startup uses the funds raised to hit its desired milestones. Because of this, they managed to subsequently raise a $10M Series B at a $30M post-money valuation. Here’s what would happen to the bridge round investors at Series B, depending on whether a valuation cap or discount rate was used:

  • Convertible note raised at $10M valuation cap. The bridge round investors effectively get to invest in the Series B at a $10M post-money valuation (instead of $30M).
  • Convertible note raised with 40% discount rate. The bridge round investors effectively get to invest in the Series B at an $18M post-money valuation (60% x $30M).

This is an “everybody wins” scenario, where the bridge round helped the startup raise its subsequent Series B with a nice valuation bump. But not every bridge financing round will necessarily lead to a successful next round with increased valuations—especially if the company is in distress. That’s why both founders and investors must be cautious when raising or investing in bridge rounds.

Key Considerations When Raising a Bridge Financing Round

On the founder’s part, they should understand that:

  • Offering lower bridge round valuations could put off future investors. While it may be necessary to offer lower valuations to bridge round investors to get the round done, this may deter future investors if they can’t get the same favorable terms. 
  • They must be able to adequately explain the reasoning behind the bridge round. Because investors often associate bridge rounds with distressed companies, founders might face hesitancies from existing and new investors. Founders should have a compelling rationale for the round, whether it's to capitalize on current growth or provide additional runway to test a new idea.
  • They may have to make certain sacrifices to close the bridge round. In cases where the bridge round is to save a struggling company, founders might have to make certain sacrifices in exchange. For example, when founder Jason Lemkin had to raise a bridge round for his company, he also had to forgo a year’s salary.

As for investors, they should understand that: 

  • Choosing not to participate in a bridge round may result in the company going under. If the company is struggling, then sitting out of a bridge round may result in the company going under. This fear can push investors to fund the bridge round. But investors should be wary of falling for the “sunk cost fallacy.” It may not be worth throwing good money after bad. Further, even if the company must be liquidated, investors could still see some capital returned, depending on their liquidation preference.
  • Doing proper due diligence to determine the true purpose of the bridge round is essential.  Investors should work closely with founders to identify the purpose of the bridge round and ensure the capital is used appropriately. This may require a little extra time from the investor to fully understand the startup’s situation.  Also, be wary of so-called “plus rounds” or “prime rounds.” These can be legitimate follow-on rounds used when the original round was oversubscribed, and the founders want to take on new investors. But in some cases, founders may use these labels to make a bridge round appear more palatable.
  • The bridge round could be a good opportunity to negotiate favorable terms. The “urgency factor” in many bridge rounds might give investors the leverage to ask for favorable terms, such as a lower valuation cap on a convertible note.

Should You Invest in a Bridge Round?

What should investors think about if one of their startups approaches them for a bridge round? While every case is different, a few useful questions might be:

  • Have the founders provided regular updates? Good founders will provide investors regular updates containing details like the startup’s monthly burn rate and when the cash runway is expected to end. If this had been provided, then not only will the bridge round be less of a surprise, but it indicates that the founder may be capable and worthy of a financial lifeline. 
  • Is there a lot of time pressure on this round? If a bridge round comes as a surprise, it may be a sign of increased distress.
  • Have other investors agreed to join in on the round? The actions (or inaction) of other investors may point toward their own confidence in the company.
  • What are the chances of the company succeeding if this bridge round goes through? There’s no one objective way to answer this question. It mostly depends on the investors’ due diligence. 

Bridge Rounds: A Sometimes Necessary Evil

Bridge rounds are often not ideal. But they might be the difference between a failed startup and one that survives to fight another day. 

Authors
Ian Lee
Financial Writer
Kate Bridge
Legal Counsel, AngelList
Maria LoPreiato-Bergan
LP Relations, AngelList
Jim Tomczyk
GP Relations, AngelList
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