Bridge financing, often in the form of a bridge loan, is a temporary financing option used by companies and other entities to consolidate their financial position in the short term until a long-term or permanent financing mechanism can be set up. Bridge financing is usually provided by an investment bank (in the form of a loan) or a venture capital scheme (where the loan is granted against equity in return).
Bridge funding “bridges” the gap between the time when finances are declining and the time when they are expected to make massive and planned increases. This type of financing is usually used to cover a company’s short-term working capital needs, either when it is just established or when it operates on a seasonal basis (in terms of its purchases or sales).
Bridge financing is also used for initial public offering (IPOs) or may include equity swaps against the loan.
How the bridge financing works
There are many ways in which bridge financing can be organized. Which option a business uses will depend on the actual circumstances. Financing – bridge options include debt financing, equity financing and initial public offering.
Financing – debt bridge
A bridge financing option is for a company to enter into a short term high interest loan, known as a bridge loan. Companies seeking to finance the bridge through a bridge loan must be careful, however, because interest rates are sometimes so high as to cause further financial struggles.
If, for example, a company has already been approved for a bank loan of EUR 500,000, but the loan has been divided into tranches, with the first installment reaching six months, the company may apply for a bridge loan. He can apply for a six-month short-term loan, which gives him enough money to survive until the first installment hits his bank account.
Financing equity bridge
Sometimes companies do not want to be in debt with great interest. If this is the case, they may look for venture capital companies to provide a bridge financing bridge and thus provide the company with capital until it can raise a larger share financing round (if it so wishes).
In this scenario, the company may choose to offer equity ownership of the venture in exchange for several months to one year of value financing. The venture capital firm will receive such an arrangement if it believes that the company will ultimately become profitable, which will see its share of the company increase in value.
Financing the bridge during an IPO
Financing the bridge, in investment banking terms, is a method of financing used by companies prior to the IPO. This type of bridge financing is designed to cover the costs associated with the IPO and is usually short-term in nature. Once the registration is complete, the cash raised from the offer will immediately pay off the loan.
These funds are usually provided by the investment bank that undertakes the new issue. As a payment, the company acquiring the financing of the bridge will give a series of shares to the contractors at a discount to the issue price that offsets the loan. This funding is, in essence, a promotional payment for the future sale of the new version.
Example of financing the bridge
Bridge financing is common in many industries, as there are always racing companies. The mining sector is full of small players who often use bridges to develop a mine or cover costs until they can issue more shares – a common way to raise funds in the sector.
Funding for the bridge is rarely simple and often includes some provisions that help protect the entity providing the funding.
A mining company could secure 12m euros in financing for the development of a new mine that is expected to generate 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 annum and requires a one year return.
The term loan may also include other provisions. These may include an interest rate increase if the loan is not repaid on time. It can be increased to 25%, for example.
The venture capital firm may also apply a convertibility clause. This means that they can convert a certain amount of the loan into equity, at an agreed share price, if the venture capital firm decides to do so. For example, EUR 4 million of the EUR 12 million loan can be converted into EUR 5 per share at the risk of a venture capital crisis. The price of 5 euros may be negotiated or may be simply the price of the company’s shares at the time of the agreement.