What Is Bridge Capital: Short-Term Business Funding Option

As a business owner, you understand the importance of carefully managing your resources. Securing long-term capital to run and grow your business is straightforward. But what about shorter-term capital needs? Have you thought about how to handle a gap in your business’s financing strategy?

Bridge capital is short-term financing that covers urgent but temporary cash-flow needs until long-term funding is secured. This sort of financing is most beneficial when the company expects a large cash inflow in the near- to mid-term, such as funding via permanent financing or an IPO. Businesses often access bridge funding to take advantage of growth opportunities that require capital on a short time frame, such as an opportunistic purchase of an asset at a discounted price or funding necessary business operations until the next round of funding closes. 

But what is bridge capital, exactly? And what is a bridge fund?

Bridge Capital Defined

Bridge capital is often issued by investment banks, small business investment companies (SBICs), private equity (PE) firms, or venture capital (VC) firms, depending on the borrower’s situation and profile. Due to the potentially higher default risk on short-term loans, bridge funding often means higher interest rates or discounted equity valuations for the borrower. 

However, it’s important to note that seeking bridge funding doesn’t necessarily indicate a company is in financial distress. Strong companies often require additional capital to finance short-term business activities while their long-term financing needs are being secured.

One benefit of bridge capital apart from fast funding times is the flexibility to structure terms that fit both lender and borrower needs. These terms typically depend on the borrowing company’s credit profile and overall financial situation. Companies possessing stronger credit profiles receive more favorable terms. 

Lending agreements are designed to protect lenders while ensuring businesses get the capital they need. Interest rates and equity discounts reflect the risk associated with bridge loans and protect the bridge investment fund from losing its principal. Borrowers failing to repay the loan on time may face interest rate penalties. As an alternative, some bridge finance structures allow the lender to convert the outstanding loan amount to equity shares in the borrowing company at a favorable price.

Types of Bridge Capital

Bridge funding applies to three main categories: debt bridge financing, equity bridge financing, and IPO bridge financing.

Debt Bridge Capital

A bridge capital loan is similar to traditional debt financing, except that the company borrows money for a relatively short period—often one year or less. For example, these funds can cover asset purchases or operating expenses during the period before a long-term loan kicks in. 

The borrower pays interest based on their level of risk, but interest rates are generally higher than with longer-term debt. For this reason, it’s essential to exercise caution with a bridge loan. Depending on the reason for the bridge loan, the higher interest rates could lead to a cash crunch in the longer term.

Equity Bridge Capital

Companies that do not wish to borrow funds at elevated interest rates may instead choose to seek out equity bridge capital. Equity bridge capital is essentially a quickly funded equity raise, often at a discounted valuation. This arrangement allows the issuer of the equity to sell a typically small amount of the company at a discount to a private equity firm in a quick transaction. This provides the company with fast access to capital while allowing the investor to continue to own the shares or sell them, either back to the company or in the open market.

IPO Bridge Capital

An IPO can generate vast amounts of capital for a company. But going through the IPO process can also be very expensive. When preparing for an IPO, companies are responsible for the fees surrounding the due diligence, underwriting commissions, and legal fees, which typically total 5-10% of the funds raised. This can be too much for a cash-strapped company to cover on its own.

However, the newly funded company would have no issue covering the IPO expenses after the IPO is complete. To cover these short-term costs, the company going public may give the investment bank underwriting the IPO a number of shares at a discounted price in exchange for covering the fees. The investment bank would then sell these shares in the market and recoup their investment.

Example of Bridge Capital at Work

Imagine a biotech company developing a revolutionary treatment for a common seasonal illness—like the cold or influenza. The FDA approval process is uncertain, and a decision is expected later in the year. If successful, the product will be wildly popular and profitable. 

But developing the technology is capital intensive. The biotech company needs manufacturing equipment and a production team to secure a successful launch. Due to insufficient cash reserves, the finance team projects a $1.5 million shortfall in the time leading up to the approval.

Management decides to use bridge capital to cover the shortfall. Here are two possible scenarios:

1. The biotech company could approach an investment fund to secure a bridge capital loan. Despite the potential default risk, the loan is approved quickly and carries an interest rate of 17%. The terms are strict, and the borrower must repay the loan within one year. Otherwise, the interest rate will increase to 20%.
2. Alternatively, the biotech company may seek equity bridge capital for the necessary $1.5 million capital funding. The bridge investment fund agrees to finance the product launch for a 10% equity stake in the biotech company at a 50% discount compared to its current valuation.

Both scenarios secure the treatment’s successful launch.

How to Get Bridge Capital Financing

Bridge funding might be the best option for your business to cover short-term cash needs while finalizing long-term financing. Perhaps you’ve secured long-term debt, but the loan won’t close for another two months, or you’re on your way to an IPO. Maybe you want to take advantage of a discounted asset purchase but have to act quickly.

Although a traditional bank probably isn’t the right partner for your bridge capital needs, a PE firm or investment bank is. The right partner will have access to capital and the risk appetite to find a bridge finance solution for debt, equity, and IPOs.

To get bridge capital financing, talk to a PE firm that specializes in investing in companies like yours. They’ll know the best option for getting you the cash you need to grow your business. Together, you can define what a bridge loan or funding means for your company, and they can walk you through the process of lining up a suitable bridge capital solution.