EGD News #187 — Bridge Rounds: Startup Lifelines in 2023

The bridge round is done as a result of an insufficient runway, under unfavorable conditions, in either the progress of the company or some macro environment events, like the hard times of 2023, where VC funding isn’t as readily available as it was during 2020 or 2021.

A bridge round is usually initiated in agreement with existing investors, who are willing to support the company during hard times, or a bump in the road.

When is a bridge round appropriate? Let’s talk about the situations where a bridge round might be necessary:

From the investor perspective, the bridge round should be done when the startup is doing OK but not good enough yet to raise at a higher valuation.

From the founder’s perspective, the bridge round becomes an option when you realize that you won’t be able to raise a bigger round before the money runs out. For the last year or so, I’ve been telling founders to be more proactive and to close a bridge when they have less than 12 months of runway.

There are a couple of reasons why the 12 months runway point makes sense:

1. You will know if your investors are willing to back you. Measure how they think about you by floating the idea of a bridge round and why you’d want to do it. You can then plan what needs to happen in the next six months to be able to raise the bridge. You might need to pivot. You might need to change people. You might need to move quickly, and you might need to start sending regular investor updates because the investors have no clue what’s been happening.

2. More runway, less risky for the company. Getting them to commit early to a bridge gives you a chance to play the upper hand in the negotiations for the bridge. The closer to the cash-ends-date you are, the more likely it will be that the investor will want favorable terms, i.e., the same valuation as with the previous round, so starting the bridge round early gives you leverage.

If you are already at less than 12 months of runway left, continue reading to prepare for a bridge.

How to prepare for a bridge round

Investors will think about several things as a startup approaches them for a bridge round.

Are the founders keeping investors in the loop? Great founders will keep their investors informed with updates on product progress, cash balance, burn, and runway. This way, a bridge round won’t come as a shock, and it shows that the founders are responsible and worthy of financial support.

How long is the current runway, and when does the company need the funding? If there is urgency and “we need the money next week,” investors might be less favorable to give support for an urgent bridge.

Evaluating the likelihood of the bridge succeeding. There will be a lot of variables that the investors will want to understand to assess the probability of success, where the company uses the bridge funding to go to the next stage.

I want to expand on the evaluation of a company needing a bridge. What investors will be looking at: is the company shown the ability to make progress, and has the market for the company’s product favorable? Do the founders understand the need to keep the operation lean while they “travel the bridge?”

Here is the key question the existing VCs: will the company be able to raise the next round after the financing from the bridge round? The VC doesn’t want to be faced with a scenario where the bridge financing runs out and the company shuts down.

The VC could realize that the startup they’ve invested in is not what they thought it would be and likely never will be, and they shouldn’t keep putting new money into it just because of the capital and time invested in supporting the company.

Where to start

Your lead investor from your previous round should be your point of contact on starting talks about a bridge round. You should have an extremely open dialogue with them. You want to turn all stones, maybe there is a solution that doesn’t involve additional money from existing investors. Many investors have seen scenarios play out where founders pivot the company, change course, bring in revenue with work-for-hire, etc. Great investors will want to spend time with the founder on coming up with solutions.

In any case, the founders need to set a proper and believable plan in place which is achievable with the new funding so that they can paint a picture of where the bridge leads.

Use your investors to craft this plan!

To prepare, think about these ingredients for a bridge round:

• What is the bridge round for? (one of the three mentioned earlier)
• How much money do you need, and how much runway will that give?
• Why is this additional runway sufficient to get to the next round?What are the options of not doing a bridge round, likelihood of those materializing, the pros and cons, etc.

The process of securing a bridge round

Let’s talk about getting investors on your bridge round.

After you’ve convinced your existing investors to invest in the bridge, you’ll want to reach out to other investors regarding the bridge and them possibly joining the round.

Trying to get a new lead or co-lead investor into the bridge round is worthwhile. If you ever need to bridge again, the new investor won’t have the baggage of doing a bridge in your company previously.

Bridging a company will not be possible for all venture funds. A big fund could have invested $1m into your pre-seed, and then they’ve set aside $1m as reserves to invest in the next round, be it at a bigger valuation or a bridge. But not every fund can afford to put $1m on the side for each investment. So ask your prospective lead investor if they can write a new cheque into the company at a later stage. You can ask them now if you haven’t asked. It will help you sleep better if they can. If not, continue reading.

Negotiating terms and closing the deal

The further you are from running out of money, the better your leverage will be in negotiating with your investors. Besides the valuation, you’ll want to visit a few other terms that might come up. It’s preferable to raise with a convertible note, as it will be quick to issue, and the cash can move quickly without much additional paperwork.

Many investors will want to invest at a capped valuation based on the previous round’s valuation. If the company has made significant progress and is doing things well, there might not be a need to justify a valuation bump. But since existing VCs don’t usually want to set terms in a company’s new funding round, they can leave this open for a future funding round, which could happen with an uncapped note.

When an uncapped note is used, investors are often keen to ask for a discount on the convertible so that the discount will be applied in a situation where the company will raise another round with a new valuation. The discount can be in the range of 10% to 20%.

To summarize the term alternatives:

Valuation cap set with post-money of last round or close to the previous round. This happens when the company is still burning cash and hasn’t made significant progress since the previous round

Uncapped note with a discount. The company has made significant progress towards breakeven or a new funding round but cannot continue with existing burn and headcount without additional funding.

Challenges and considerations of a bridge round

A bridge round has many risks and drawbacks, mainly on the investor side. Investors will spend much time thinking about the repercussions of investing through a bridge round. They need to consider the following characteristics post-bridge: Will the founder continue building the company with their current motivation? It’s always worth it for the investor to ask if the founder wants to sell the company and if a bridge postpones the inevitable cash-end date or a small exit.

There are many strategies for managing potential challenges. I’m a big fan of a transparent relationship between the founder and investor. Keeping an open dialogue going is always the best approach. Investors and founders are partners in the business, and no secrets should be kept on either side.

Case studies: examples of successful bridge rounds

Example 1: Next Games raised a bridge round to Series A

We took a bridge round with Next Games in 2015 when the Walking Dead game, which we had just launched, didn’t give us enough revenue to break even with a team of over 40 people. That bridge gave us some 18 months of additional runway. We broke even in 9 months and then did the IPO 12 months later.

Example 2: My first company Ironstar pivoted to Facebook games

In 2009, our investor gave us the “cold shower” that they would not keep backing us if we didn’t kill our existing web browser game. After many discussions, I convinced my existing investors to bridge the company with 100K so we could take on Facebook games. The company did the pivot in 6 months, and we became profitable. The story didn’t end well once Facebook became inhospitable for game studios in 2011, but we managed to use the bridge to pivot and break even for an extended period.

(Photo by Nikolai Ulltang)