Bridge financing guide for startups

What is bridge financing?

Founders can raise money using several methods. Many of them bootstrap their organization, while others go to traditional lenders or other funding sources for business loans or lines of credit. Seasoned entrepreneurs might look into venture debt or convertible notes. But these are, generally, all long-term financing options.

Bridge loans, on the other hand, are a short-term financing solution. They typically have a 6-12 month repayment term, so they’re normally used to solve short-term cash flow issues. One example is to borrow enough money to finish developing a software platform. Another is to take a loan to buy inventory for a busy shopping season. A third is to cover expenses until your next fundraising round. 

The common denominator in these scenarios is an infusion of money to improve cash flow. Note that interest rates on bridge loans may be higher than traditional loans because of the shorter repayment term, but you won’t need to deal with the equity dilution of a funding round. This type of debt financing can help your company hit specific revenue milestones. 

Early-stage startups with no revenue must deal with a burn rate. That’s when operational expenses consume any funds that have been deposited by founders or existing investors. Raising money in an equity round at that stage may not be possible, leaving the business with the option of applying for a short-term loan or liquidating assets.    

Benefits and risks of bridge loans

The pros and cons of bridge financing can offset each other. They have a negative connotation with many founders because short-term loans can be a sign of financial instability. On the other hand, new debt is more appealing to shareholders than a bridge round of equity financing that dilutes the stock price. Potential investors may view that differently. 

Newer companies need to be cautious about taking on debt because it can affect the business’s book value. The baseline for pre-money valuations is the shareholder’s equity box on the balance sheet. That is calculated by subtracting liabilities from assets. Short-term debt is a liability, so it directly affects the share price, leading to a lower valuation. 

Finding a type of bridge financing with more favorable terms could satisfy shareholders and new investors because it can be repaid faster. This should be taken into account when doing the financial planning for the next round of funding. Timing the final loan repayment to coincide with a seed or Series A round could create more growth opportunities for the company. 

The other side of this coin is taking out a bridge loan with an unreasonable repayment term and an exorbitant interest rate. That could create a debt crisis that requires additional funding to solve. It’s best to avoid this scenario.     

Bridge loans vs other financing options

Every startup is different, so there’s no one-size-fits-all solution to acquiring funds. Bridge loans are one option, but additional capital may be needed later. It’s best to evaluate the cost and benefits of other options before taking on new debt. Here’s how bridge loans compare to other financing options your startup might consider:   

Venture debt

Venture capitalists don’t always require equity in exchange for funds. Some will offer venture debt to help a startup get to the next level. This is often done with an agreement that the VC will get the first option to invest during the next fundraising round. Startups with new technology may go this route to finish developing their platform or application before going to market.   

Traditional loans 

Banks and credit unions offer traditional term loans with fixed monthly payments and lower interest rates than bridge loans. Unfortunately, startups with limited financial history may not qualify for this option. Banks usually want at least three years of bank statements and a good business credit score for loan approvals.   

Business line of credit

A business line of credit is a more flexible loan option that allows the business to repay the loan early and access the funds again if needed. Retail businesses often use lines of credit to buy additional inventory before a busy shopping season. Construction companies or developers may apply for an LOC to cover the cost of materials and labor before they get paid. 

Equity financing

Opting for equity financing too early in the life of the company can have long-term negative effects on owners and shareholders. Trading equity for funding may cause stock dilution if common stock changes hands. Using preferred stock with liquidation preferences can mitigate some of that. Using convertible notes or options could create a valuation cap. 

Wrap up

Bridge loans can be an option for startups in need of quick access to capital. It can be used to adapt to changing market conditions, cover operating expenses, or pay off other debt to make the company more attractive to future investors. Some founders use bridge loans for product development before a financing round or initial public offering (IPO).

There are different types of bridge loans, some more cost-effective than others. It’s important to shop several options and look at alternative funding solutions. These include venture debt, traditional bank loans, business lines of credit, and equity financing. Each has benefits and drawbacks that should be researched carefully. 

Having enough capital is essential for a startup’s success. As you grow your business, focus on what matters—your product and customers. Rho's finance platform helps you manage cash and automate finance busywork, so you can focus on growing your business.

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