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 usually 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.

How Bridge Financing Works

Bridge financing "bridges" the gap between when a company's money is set to run out and when it can expect to receive an infusion of funds later. This type of financing is most customarily 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 some short-term help may have more options than a company facing more significant 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. However, Companies seeking bridge financing through a bridge loan need to be careful 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 enough money to survive until the first tranche hits the company's bank account.

Equity Bridge Financing

Sometimes, companies want to avoid incurring 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 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 it believes 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. 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 several 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 struggling companies always exist. The mining sector is filled with small players who often use bridge financing to develop a mine or cover costs until they can issue more shares—a common way of raising funds in the sector.

Bridge financing is more complex and often includes several provisions that help protect the entity providing the funding.

A mining company may secure $12 million in funding to develop a new mine, 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 interest rate increase 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 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 when the deal is struck.

Other terms may include mandatory and immediate repayment if the company gets additional funding that exceeds the loan's outstanding balance.

FINAL COMMENTS:

A bridge loan—short-term financing used until a person or company secures permanent financing or settles an existing obligation—is often used in residential real estate. Still, many types of businesses use them as well. Homeowners can use bridge loans to purchase a new home while they wait for their current home to sell.?Businesses seek bridge loans when awaiting longer-term financing and need money to cover expenses in the interim. However, these loans typically carry a higher interest rate than other available credit facilities.