Bridge Financing Explained: Definition, Overview, and Example

Bridge Financing

Investopedia / Dennis Madamba

What Is Bridge Financing?

Bridge financing, often in the form of a bridge loan, 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 loan or equity investment.

Bridge financing is also used for initial public offerings (IPO) or may include an equity-for-capital exchange instead of a loan.

Key Takeaways

  • Bridge financing can take the form of debt or equity and can be used during an IPO.
  • 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 they believe the company will ultimately become profitable, which 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 the new 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 in many industries since there are always struggling companies. 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 the venture capital firm charges 20% per year and requires that the funds be paid back in one year.

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 they can convert a certain amount of the loan into equity, at an agreed-upon stock price, if the venture capital firm decides to do so. 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.

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