Bridge round refers to fundraising that is done to provide startups a ‘bridge’, in the form of funds, that enables them to reach the next milestone. The milestone could be anything, i.e. an IPO, Series C round, etc., which depends on the startup. In general, startups raise bridge rounds when they are just a few steps away from their next milestone, and achieving it can generate huge returns for the current shareholders. To understand more about bridge rounds, you can read this article. 

Usually, bridge rounds are not planned events. This round comes into picture due to unforeseen situations, i.e. if the company had unprecedented growth, so it needs some funds for an IPO, or if the market had too many players, so the startup needs more funds for the next milestone, etc. This is one of the primary reasons why first time founders are not completely aware of how the financials are addressed in a bridge round. Being aware of how a bridge round might influence the founders’ dilution, financials etc. can be quite useful to the startup. 

In this article, we’ll look into how bridge rounds are structured, how it influences the startup financially, and how the mechanics of the deal will unfold based on the startup. 

Different Financial Structures of Bridge Rounds

In general, bridge rounds can be structured in two forms:

1. Convertible Debt: It is a form of loan that allows investors to convert into equity with prespecified conditions. Usually, investors set conditions on both or either of the terms, i.e Valuation Cap and Discount rate. Its ease of implementation and clear financial advantage to investors makes it best for a bridge round of funding. Convertible debt is easy to execute, which means the round can be closed in the shortest time possible. Additional details about convertible debt will be discussed in the future articles. 
2. Preferred shares: Preferred shares are just like any other shares issued to investors. Depending on the situation in context, the investors can impose different conditions and ensure the safety of their investment. You can go through these articles to understand the different monetary and control terms that can be imposed by the investor.  
   
   Other than the two specified above, there’s another option that can be chosen by investors, i.e. a combination of debt and equity. However, this is quite rare, since it increases the complexity of the deal, and can prolong the fundraising process. 

Unfolding the Financials of a Bridge Round:

Most of the bridge rounds are either structured with a convertible debt or an issue of preferred equity shares. Based on whether the startup achieves its goals or couldn’t match the expectations, the mechanics will change. We’ll explore these scenarios in detail below:

1. Bridge Rounds with Convertible Notes
   Convertible notes, also known as convertible debt, will operate the same irrespective of different funding rounds. However, the conditions imposed might vary depending on the startup and the funding round in context.
   
   The terms of compensation for a convertible note will usually depend on two aspects: discount factor and a valuation cap. Discount factor means that in the next round of fundraising, the investor is issued shares at a discount of the actual share price in the funding round. A cap on valuation refers that irrespective of how high the valuation goes in the next round, the notes issuer will get a portion of the equity that is equivalent to the investment at capped valuation number. Let’s understand this with an example.
   
   Let us say that the investor Z has agreed to invest $ 1 million at a discount factor of 20%. If, in the next round, the startup is planning to raise another $ 10 million by issuing shares to new investors at $ 1000 per share, the investor Z will receive $ 1 million worth of shares, with each share issued at 20% discount, i.e. $ 800. So, instead of receiving 1000 shares per $ 1 million like new investors, the investor Z will receive 1250 shares. In this way, the investor Z is compensated for the risk taken in earlier stages
   
   Let’s consider that the current valuation of a startup is $ 25 million, and the investor Z has agreed to invest $ 1 million at a valuation cap of $ 50 million dollars. Assuming that the startup is planning to raise funds in the next round at a post-money valuation of $ 100 million, the investor Z will be issued shares worth $ 1 million at a valuation of $ 50 million dollars instead of $ 100 million. 
   
   Sometimes, investors can also set up hybrid conditions, i.e. set a discount factor only till a  specified valuation cap, or maximum of discount factor and valuation cap, etc.. Different forms of notes can be set up based on the preferences of the investors and the leverage they have on the startup. We’ll deal with the mechanics of such rounds in more detail in the future articles.
   
   All these scenarios are applicable only if the startup successfully makes a move to the next round. However, if it couldn’t perform as expected, the startup has to pay the principal and accrued interest at maturity date. If the investor forces payment at the due date, the startup might have to file for bankruptcy, which is bad for everyone. In such situations, the investors will look for a common ground that is beneficial for everyone involved. 
   
   
2. Bridge Rounds with Preferred Stock
   Issuing preferred stock takes more time than convertible notes, since there are a lot of legal procedures that need to be followed to get it right. However, issuing preferred shares in bridge rounds works the same as issuing preferred shares in any other rounds.
   
   In general, bridge rounds are driven by existing investors, since they have more at stake, and they are in a much better position to evaluate the startup. If the existing investors don’t agree to invest, it’s very difficult for the startup to onboard new investors. 
   
   In case the existing investors agree to invest, either the whole round can be funded by existing investors, or they can bring new investors onboard. Existing investors may not expect a new class of shares, since all the investors will be equally benefited from it. However, new investors might ask for higher preferences, and impose new conditions. This will mainly depend on the severity of the situation at hand, and the leverage the new investor has on the startup. 
   
   In general, depending on the preference and convenience of the parties involved, the deal can be driven either by convertible notes, or preferred stock, or a hybrid of both. 

In the Final Analysis

In this article, we have covered different ways in which a bridge round can be structured for a startup. Bridge round can play a crucial round for many startups that need just a small nudge to make it to the next level. These rounds should be optimized for speed of execution, due to which raising funds via convertible notes is considered a better option. However, a startup might have to go with preferred stock, convertible notes, or a hybrid of both based on the interest of the parties involved.