Definition
– Bridge financing is a short-term capital injection used to cover immediate cash needs until a planned, longer-term source of funding becomes available. It can take the form of a loan, an equity infusion, or a temporary financing arrangement tied to an upcoming event (for example, an initial public offering, or IPO).
Key jargon (brief)
– Tranche: a portion of a larger committed amount paid at different times.
– Convertible: a loan or security that can be exchanged for equity under specified conditions.
– Underwriter: an investment bank that helps manage and sell an IPO or other securities issuance.
How bridge financing works (step-by-step)
1. Identify the timing gap: estimate when cash runs low and when permanent financing or income will arrive.
2. Choose structure: short-term loan (bridge loan), equity injection, or an IPO bridge arranged by an underwriter.
3. Negotiate terms: interest rate, maturity, prepayment rights, covenants, and any convertibility or discounted-share provisions.
4. Use the funds to meet operating or transaction costs.
5. Repay or replace the bridge facility when the expected long-term financing closes (e.g., bank loan tranches arrive, a larger equity round closes, or IPO proceeds are received).
Types of bridge financing
– Debt bridge (bridge loan): a short-term loan, usually higher interest than standard long-term debt. May include stricter covenants or penalties for late repayment.
– Equity bridge: a private investor (for example, a venture capital firm) provides capital in exchange for equity or an equity-linked instrument.
– IPO bridge: an investment bank provides short-term financing to cover IPO preparation costs; repayment typically occurs immediately from IPO proceeds. The underwriter usually receives discounted shares as partial compensation.
Common contractual features
– High interest rates to compensate lender risk.
– Convertibility clauses allowing lender to convert some or all of the financing into equity at a predetermined price.
– Step-up provisions that increase the interest rate if the borrower misses repayment deadlines.
– Conditions that mandate repayment if the borrower secures additional financing above a certain threshold.
Small worked numeric example (based on a typical mining-stage scenario)
Assumptions:
– Company secures a $12,000,000 bridge loan for 1 year.
– Annual interest rate: 20%.
– Lender has the option to convert $4,000,000 of the loan into equity at $5 per share.
– Company had 2,000,000 shares outstanding before conversion.
Calculations:
– Annual interest cost (if repaid in 1 year): 12,000,000 × 0.20 = $2,400,000.
– If lender converts $4,000,000 at $5/share → shares issued = 4,000,000 ÷ 5 = 800,000 shares.
– New total shares = 2,000,000 + 800,000 = 2,800,000 shares.
– Lender’s post-conversion ownership = 800,000 ÷ 2,800,000 = 28.57% (dilution to existing owners).
If the company delays repayment and the interest rate steps up to 25% for the year:
– Annual interest = 12,000,000 × 0.25 = $3,000,000 (an extra $600,000 compared with 20%).
Checklist before taking bridge financing
– Confirm the precise funding gap and timing for the replacement financing.
– Compare nominal interest rate and effective cost (including fees and conversion economics).
– Check for prepayment terms and any penalties.
– Review convertibility terms: price, cap, and dilution impact.
– Ask about step-up rates and triggering events (what increases the cost).
– Identify the repayment source (IPO proceeds, tranche release, follow-on financing).
– Assess alternatives (short-term bank lines, vendor financing, cost cuts).
– Run a dilution sensitivity analysis if conversion is possible.
Pros (quick summary)
– Fast access to cash to cover urgent obligations or transaction costs.
– Flexible structures (loan, convertible debt, or equity).
– Can keep operations going while arranging larger or cheaper financing.
Cons (quick summary)
– Higher cost than most long-term financing — high interest and fees.
– Potential dilution if convertible features are exercised.
– Strict covenants or punitive step-up clauses can increase financial pressure.
– Risk of worsening the company’s position if repayment or conversion is unfavorable.
Can a bridge loan be paid off early?
– Frequently yes: many bridge loans allow early repayment and therefore offer the borrower a chance to refinance sooner at lower cost. However, this is not universal — always confirm the term sheet for prepayment penalties or other restrictions.
Main advantage
– The principal benefit is speed: bridge financing provides immediate capital to cover a temporary short
-term funding gap until longer-term financing arrives. That speed is useful when timing is critical (closing a deal, meeting a payroll deadline, or securing a property) and the borrower has a credible, near-term plan to replace the bridge with cheaper permanent financing.
Common uses
– Mergers & acquisitions: fund part of a purchase price while the buyer arranges long-term acquisition financing or completes due diligence.
– Real estate: cover a gap between buying a property and qualifying for a permanent mortgage or selling an existing asset.
– IPOs and equity raises: provide cash for operations or transaction expenses until an equity issuance closes.
– Corporate liquidity: temporary working-capital support when cash flows are uneven or receivables are delayed.
Types of bridge financing (practical shorthand)
– Secured senior bridge: collateralized and first in priority; lower cost vs. unsecured.
– Mezzanine / subordinated bridge: sits below senior debt; higher interest and may include equity kickers.
– Convertible bridge: loan converts into equity (common in startup financing); can reduce cash interest but dilutes owners.
– Asset-backed bridge: repayment tied to sale or refinancing of a specific asset (typical in property deals).
Key economic terms to check (read the term sheet carefully)
– Principal amount and maturity date (typical: 3–12 months).
– Interest rate: stated as annual
percentage; check whether it’s fixed or floating, and whether it’s quoted as a nominal rate or an annual percentage rate (APR). If floating, note the reference rate (e.g., SOFR, LIBOR legacy, or prime) and the published margin (e.g., SOFR + 450 bps). Confirm interest compounding frequency and interest-payment schedule (monthly, quarterly, or PIK—payment-in-kind).
– Fees and upfront costs: origination/arrangement fee, commitment fee, underwriting fee, de‑risking or syndication fees, and any legal or due‑diligence deposits. Know whether fees are paid out of loan proceeds (reducing net cash to the borrower) or separately.
– Payment-in-kind (PIK) vs cash interest: PIK interest accrues to the loan principal and is paid at maturity as additional principal; cash interest requires periodic cash payments. PIK raises effective borrowing cost and can escalate leverage.
– Amortization and payment structure: bullet (all principal at maturity) vs scheduled amortization. Many bridge loans are bullet.
– Security/collateral and priority: what assets secure the loan; whether the lender is senior (first priority) or subordinated; any negative pledge (limits on future liens).
– Covenants: affirmative covenants (actions the borrower must take), negative covenants (actions the borrower is restricted from), and financial covenants (e.g., minimum liquidity, maximum leverage ratios). Check events that trigger cross-defaults.
– Warrants, equity kickers, and conversion mechanics: for subordinated or convertible bridges, confirm warrant coverage, conversion price, valuation cap, discount to next round, anti-dilution protections, and impact on ownership.
– Prepayment, breakage, and exit fees: whether prepayment is allowed, required notice,
required notice, whether the borrower must pay interest during a prepayment period, how any prepayment premium is calculated, whether prepaid amounts reduce fees, and whether prepayment is allowed if the borrower converts the bridge into equity (and on what terms).
Other practical and legal issues to check
– Taxes and withholding: is any portion of the loan treated as taxable income (e.g., forgiven amounts), are there withholding obligations for interest or fees paid to foreign lenders, and who bears tax gross-up obligations?
– Hedging and interest-rate risk: if the loan has a floating rate, confirm whether swaps or caps are allowed and whether there are breakage charges if the borrower terminates a hedge.
– Syndication and assignment: can the lender sell or assign the loan, and are borrower consents required? What are the mechanics and notice periods?
– Documentation completeness: confirm executed versions of the promissory note, security agreement, intercreditor agreement (if subordinated), warrant or conversion agreements, board and shareholder approvals, and any required filings (e.g., UCC-1 financing statements in the U.S.).
– Due diligence items: lender should obtain recent financials, bank statements, cap table, material contracts, liens, litigation status, and proof of corporate authority. Borrower should verify lender funding conditions and timing.
– Regulatory and licensing checks: for regulated businesses (financial firms, healthcare, cannabis, etc.), confirm whether regulators impose limits on certain financing structures.
Quick glossary (first use defined)
– Bullet loan: a loan that pays all principal at maturity rather than in periodic principal installments.
– Amortization: the schedule of principal repayment over the loan term.
– Covenant: a contractual promise — affirmative covenants require certain actions; negative covenants restrict actions.
– Warrant: a security giving the holder the right to buy equity at a set price under specified terms.
– Exit fee / breakage fee: a fee payable when the loan is repaid, refinanced, or the borrower exits the facility.
Borrower checklist before signing a bridge facility
1. Confirm exact amount available at closing and net proceeds after upfront fees.
2. Identify all fees (origination, commitment, arrangement, exit, legal, advisor) and when they are payable.
3. Verify term and automatic extension mechanisms (if any) and the cost of an extension.
4. Understand interest calculation (simple vs. compounded, day-count convention) and payment dates.
5. Check security package and ranking: which assets are pledged and where the lender sits in priority.
6. Review covenants and triggers for default & remedies; confirm cure periods and cross-default breadth.
7. Confirm conversion or equity-kicker mechanics: conversion price, discount, valuation cap, warrant coverage, and anti-dilution.
8. Ask for sample payoff statements and confirm process for repayment or conversion.
9. Run a cash-flow test: can you afford the maturity payment if the equity round or exit delays?
10. Get tax counsel for any gross
10. Get tax counsel for any gross-up provisions, withholding obligations, or conversion tax treatment. Gross-up: a contractual clause requiring the borrower or issuer to increase payments so the lender receives a net amount after taxes. Conversion tax treatment: whether conversion of debt into equity creates a taxable event for the company or investor. Confirm who bears payroll, withholding, sales, VAT, or transfer taxes on any equity issuance.
11. Run cap‑table and dilution scenarios. Prepare alternative post‑round capitalization tables showing:
– A straight equity round (no conversion).
– Conversion of the bridge at the stated discount.
– Conversion at the valuation cap.
– Conversion plus warrant exercise (if applicable).
Check founder %, investor %, option pool size, and anti‑dilution mechanics. Use a spreadsheet model and stress‑test with multiple round sizes and prices.
12. Stress‑test liquidity and runway. Translate the bridge into a cash‑flow calendar:
– When is each interest payment, if any, due?
– When is the principal due?
– If conversion is optional, when is the decision deadline?
Model adverse scenarios (round delayed by 3, 6, 12 months) and confirm the company can survive without the anticipated equity inflow.
13. Confirm enforcement and default risk in practice. Review lender reputation and past behavior. Ask:
– How often does this lender accelerate on minor covenant breaches?
– Have they enforced warrant strips or changed conversion outcomes post‑close?
Request references or examples from other founders.
14. Negotiate practical borrower protections. Typical items to push on:
– Reasonable cure periods and notice requirements before default.
– Limitations on acceleration for immaterial breaches.
– Cap on default interest and fees.
– Narrow cross‑default definitions (avoid global cross‑defaults to unrelated financings).
15. Make negotiation points on conversion mechanics explicit. Insist the agreement clearly defines:
– Conversion price formula (show worked numeric examples in the contract).
– Which round triggers conversion (qualified financing threshold in dollars).
– Treatment of accrued interest on conversion (converted or paid).
– Interaction between discount and valuation cap (usually the investor gets the more favorable of the two).
16. Consider alternative structures. Compare bridge financing versus:
– Priced equity round (avoid conversion uncertainty).
– SAFEs (simple agreement for future equity) — simpler but different investor protections.
– Revenue‑based financing or short‑term loans from existing investors.
Weigh speed and costs against dilution and governance tradeoffs.
Practical worked examples
A. Cash‑flow test (maturity repayment)
– Loan: $1,000,000 face principal.
– Interest: simple interest at 8% per annum.
– Term: 9 months (0.75 year).
Interest = Principal × Rate × Time = 1,000,000 × 0.08 × 0.75 = $60,000.
Maturity payment = Principal + Interest = $1,000,000 + $60,000 = $1,060,000.
If company cannot raise by maturity, confirm whether extension/how much it costs or whether interest compounds (if compounding, compute accordingly).
B. Conversion math with discount vs. cap
– Note: $200,000 convertible note, 20% discount, $4,000,000 valuation cap.
– Next priced round: $8,000,000 pre‑money; new round price = $8M ÷ 4,000,000 shares = $2.00 per share (assume 4,000,000 existing shares for simplicity).
Discounted price = $2.00 × (1 − 0.20) = $1.60 per share → shares = 200,000 ÷ 1.60 = 125,000 shares.
Cap‑implied price = Valuation cap ÷ existing shares = 4,000,000 ÷ 4,000,000 = $1.00 per share → shares = 200,000 ÷ 1.00 = 200,000 shares.
Investor receives the more favorable outcome (usually the lower price), so they convert at
at the cap-implied price of $1.00 per share and therefore receives 200,000 shares.
C. Interest accrual and conversion math
– Formula (simple interest): Amount at conversion = Principal × (1 + r × t), where r is annual interest rate (decimal) and t is years.
– Example: $200,000 note, 8% annual simple interest, 1 year → Amount = 200,000 × (1 + 0.08 × 1) = $216,000. If conversion price = $1.60, shares = 216,000 ÷ 1.60 = 135,000 shares.
– Formula (compounded interest): Amount at conversion = Principal × (1 + r/n)^(n×t), where n is compounding periods per year.
– Example: $200,000, 8% compounded monthly for 1 year → Amount = 200,000 × (1 + 0.08/12)^(12) ≈ 200,000 × 1.083 ≈ $216,600. If conversion price = $1.00, shares = 216,600 ÷ 1.00 = 216,600 shares.
– Practical point: Documents should state whether interest is simple or compounded, the compounding frequency, and whether interest converts with principal or is paid in cash.
D. Extensions, defaults, and repayment
– Common outcomes at maturity:
1. Conversion (if a qualifying priced round or per note terms).
2. Extension (mutual agreement; often with an extension fee or higher interest).
3. Repayment (cash payoff if company has the cash and note is not convertible by default).
4. Default remedies for investors (acceleration, liens, or negotiated workout).
– Example: Note matures at 12 months; company asks for a 6‑month extension with a 1% extension fee. A $200,000 note → extension fee = $2,000 (usually paid in cash or added to principal).
– Always confirm: who can authorize an extension (board, lead investor), and whether unpaid interest capitalizes.
E. Key terms to watch when negotiating or reviewing bridge/convertible notes
– Valuation cap: ceiling on the company valuation used for conversion price calculation. Clarify whether cap is pre‑money or post‑money.
– Discount: percentage reduction off the next round’s price per share.
– Qualified financing trigger: the minimum size of the next round required to trigger automatic conversion.
– Interest rate and compounding: simple vs. compound and frequency.
– Maturity date and extension mechanics: fees, approvals, and effective new maturity.
– Security and priority: whether the note is secured (collateral) or unsecured; seniority relative to other debt.
– Covenants and restrictions: affirmative and negative covenants that affect operations.
– Pro rata / participation rights: does the investor have right to maintain ownership in later rounds?
– MFN (most-favored nation) clauses and anti-dilution protections: common in investor-favorable docs.
– Board/observer rights and information rights.
F. Practical checklist — what founders should do before taking bridge financing
1. Verify conversion formulas in the note and run sample scenarios (discount-only, cap-only, discount+cap, with interest).
2. Confirm whether the valuation cap is pre- or post-money; compute implied ownership in both cases.
3. Check the qualified financing threshold and whether existing investors can block conversion.
4. Understand maturity, extension process, fees, and who must approve extensions.
5. Assess effect on cap table under different exit and financing scenarios (use a simple cap‑table model).
6. Negotiate pro rata rights and information rights separately from the economic terms.
7. Get legal counsel to ensure definitions (e.g., “price per share,” “shares outstanding”) match your intent.
8. Consider alternatives (SAFE, priced round, venture debt) and run a comparative cost/dilution analysis.
G. Practical checklist — what investors should check
1. Confirm conversion math, interest terms, and whether interest converts.
2. Check qualifying financing size and protection against hostile dilution (anti-dilution, MFN).
3. Verify whether the note is senior or subordinated to other debt.
4. Insist on clear default remedies and reasonable extension mechanics.
5. Preserve pro rata and information rights to monitor and follow-on.
6. Run sensitivity scenarios (higher