Financing Options: Bridge Loans
Today's post in the financing options series on MBA Mondays is about Bridge Loans. Bridge loans are so called because they are a "bridge" to something else. They are short term loans intended to fund a company to an anticipated event in the future.
Bridge loans exist in many sectors outside of the startup world. Big banks will often bridge companies to transactions they are putting together for them. Real estate transactions are often bridged to a closing. The concept of short term transaction driven loans is universal in business.
In the startup world, bridge loans are a particularly interesting case to study. I've been in and around startups for 25 years now and I have rarely seen a bridge loan made by anyone other than an existing investor or investor group. Most bridge loans in the startup world are made to money losing companies that are going to run out of funds before they can close a financing or sale transaction. These are very risky loans that will not get paid back unless a transaction happens and often the transactions that are required don't happen.
If you could assemble a data dump of all bridge loans made by VCs and angel investors to startups over the past twenty five years, I think you'd see that the aggregate performance of these bridge loans would be awful. I'm certain that the performance of bridge loans made by firms I've been associated with in that time is hugely negative. The loss rate is very high and the returns on the ones that work are not much better than a typical venture investment.
So why do VCs and angels make bridge loans when they perform so poorly? There are two reasons, and they are related but they are not the same. First, investors like to give the companies and teams they have backed a chance at success. Contrary to the popular view, VCs and angels are supportive of their portfolio companies well beyond what a hard nosed rational investor would be. I have seen startup investors make follow on investments many times that make no sense other than on a "doing the right thing" basis. Second, many investors are playing defense with these loans. They know they've made a weak or outright bad investment but they don't want to acknowledge it with a writeoff, so they keep putting in good money after bad.
So bridge loans are often bad investments made defensively. And so they are red flags to other investors. When a new investor looks at a company and sees a bridge loan in place, they will understand that all is not well. This doesn't mean you shouldn't make or receive a bridge loan. It just means you will need to explain it. And it will make closing a financing more challenging.
Bridge loans made in anticipation of a sale are a bit different. There is a really strong rationale for making a bridge loan in anticipation of a sale. The investors know that a sale is coming so a priced equity round doesn't make much sense. The company can't sell equity cheap relative to what the expected sale price will be. And if the equity is priced close to the expected sale price, then there will not be an equity return when the sale closes. So a loan makes the most sense. And bridge loans are the best kinds of loans to do in this situation. An acquirer will not be terribly surprised to see a bridge loan in place when they look at the books and thus it is not nearly the same kind of red flag as it is in an equity financing.
When making a bridge loan, it is critical that the size of the loan be sufficient to get to the transaction you are bridging to. The bridge metaphor is a good one. You want the bridge to be long enough to cross the river. Otherwise it does no good. Getting a second bridge done is always very hard. So if you think you need three months to sell the company or get a fiancing done, get six months of burn in your bridge.
The biggest concern investors will have in making a bridge is the probability of a tranaction closing. Investors will not make a "bridge to nowhere." So before you can realistically ask for a bridge, you must build a strong case for the transaction you want the investors to bridge to. Getting a banker or an advisor hired to help you secure the transaction you want is one good way to give investors comfort in making a bridge. It doesn't guarantee that you will get a deal done, but it shows everyone that you are committed to making it happen.
The terms of bridge loans are pretty standard. The loan will be secured by all the assets of the business that can be pledged. If there is existing bank debt or equipment financing, the bridge will be subordinate to those loans. And you will need the bank's cooperation getting a bridge done if there is a bank involved. Sometimes that is not easy.
The loan will carry an interest rate of between 6% and 12% depending on the current rate environment and will have warrant coverage or a discount. We covered the concepts of warrant coverage and discounts in the convertible debt post earlier in this series. Bridge loans are a specialized form of convertible debt.
In summary, bridge loans are common in all businesses. In the startup world they are often a sign of distress and for that reason you should try to avoid them if you can. But when you are sinking, any lifeline looks good and bridge loans are no different. Beggars can't be choosers. In a sale process, bridge loans are less problematic and are often the right solution to financing a company to a sale transaction. For startup investors, bridge loans in the aggregate are a poor performing investment and as an industry, we dislike making them. But like all of the tools at our disposal in the statup world, bridge loans are a reality of our lives, we will all experience them from time to time, and they can be a useful form of financing at a critical time in the life of a company.
In the start-up world as much as you the investor dislike making them, I guarantee you it is nothing compared to the pain of the company taking them.But I will grant you they are on a whole bad for the start-up investors. On a bridge to a sale, I remember living on Wall Street for the infamous First Boston/Ohio Mattress bridge loan.
I agree Phil. I didn’t mean to come off as a whiner. I just wanted entrepreneurs to understand why they are hated so much
Not at all Fred. You write from the VC perspective, I comment from the Entrepreneur perspective.Its why I like to comment so much. Don’t change.
i promise i won’t become an entrepreneur!
Pity. You could have done a reverse Suster.
and i promise i won’t become a vc!
Freddie, Freddie, Freddie — You don’t want to hear this but you are — just in a different way.You have made big spicy sausage in a small hand cranked sausage stuffer. And it is a thing of beauty.Your strategy of investing and managing meaningful amounts of OPM in a boutique setting while maintaining intimate control is a very entrepreneurial reaction to other market forces which might otherwise have influenced you to grow.The Event Space is a hand crafted bit of strategy which only a salty hand could see. It is the subtle difference between fly fishing and fishing w/ dynamite.When you invest pocket change in the 1/3 that you lose your worm on and big money in the 1/3 that are long balls w/ men on base — you are making a better widget.Your widgets just have George Washington’s and Ben Franklin’s faces on them.As Dad’s like to say — that one, he’s a clever child.The picture BTW is from ROK in mid 1970s when I was blasting out bridge abutments underwater and let my guys do some fishing. They were not flyfishermen.
Does the EPA apply to federal employees on foriegn soil? Is there a statute of limitations in the EPA?Anyone?;-)”Never argue w/ a guy who has a truckload of C4 and knows how to use it” – now there’s a life lesson worth remembering!
@jameshrh:disqus In those days, we WERE the EPA, we just weren’t very good at it.Never argue w/ a guy who has a truckload of C4 and knows how to use it.I had to dive w/ gear and fight the current to get the explosives under those abutments. One of the best days’ work of my entire life.I always followed the formula of multiplying by 50 and then rounding up to the next crate size.And, yes, the fish were quite delicious. This was just before the fish began to rain down. They were NK fish as we were just down from where the Imjin came out of NK.If you look very, very carefully, you can see the fish. This is what about 150 lbs of C4 wedged under a huge bridge abutment looks like.I wanted to build a floating bridge on this site and the old bridge abutments — destroyed during the Korean War in the 1950s were in the way.
blasting is in my DNA since it was my dad’s job in korea and his hearing is mostly gone because of it
What is the first Boston/Ohio Mattress bridge loan?
Look it up on wikipedia. Oversimplification: it started the beginning of the merger of commercial banks and investment banks.
Good stuff. If the phrase ‘bridge loan’ should be viewed as a caution flag, how do VCs cloak their characteristics to the outside (ie. less knowledgeable) world?
I don’t think that can be done
Reading your headline today gave me the shakes.I still remember the bridge loan we got from the Silicon Valley Bank 14 years ago.The problem, to steal a phrase, is the “bridge to nowhere” part. In Yoyodyne’s case, we knew that there was something great on the horizon, but we didn’t know what or when. And the bridge was liking a ticking bomb.In retrospect, everyone won (especially the bank), but I agree, it’s probably a no resort, not a last resort. One giant lesson I took away is that brinkmanship is a dumb strategy, and you should take certain tools off the table, even if they work now and then.
Memories! That was a bridge that worked
From 30,000′, the big difference is the talent level and the ability to execute under pressure. If you actually can walk a tight rope between two buildings at 400′, then it really isn’t risky.One’s man’s risk is another man’s journeyman’s performance.The second time is easier and the tenth easier still.On several occasions doing modest sized but meaningful turnarounds, I have bet the entire enchilada on a bridge loan but have always had the comfort that even in the worst of situations I was the “talent” and sooner or later it would work.You got jockeys. You got horses. But you cannot win a steeplechase without the right combination. Horses for courses.Luckily, I never had to test the theory completely.Oh, how I remember the lying in bed and thinking through all of the alternatives and finding the one that worked. That is living. Harsh living but living.Brinksmanship is a dumb strategy but sometimes brinkmanship is one hell of a value creator.You have to look into the abyss sometimes to learn it is only 2′ deep.
Channeling your inner Charlie Chaplin. There is a quote from him that is something like:Q: The action scenes and stunts, like the wall that falls and the window opening goes over you, you must be scared……CC: No. Its pretty easy if you know what you are doing.It automatically made me think of the reverse premise – everything is hard if you don’t know what you are doing!
Yes, I remember that quote. It was given on the occasion of his having done some of his own stunts in his movies.The problem with experience is getting the first repetition.It’s like jumping out of an airplane. The first time is easy, easy, easy — cause you have no idea what to expect.The second time is an informed decision.I am going through some old albums tonight and I came across this picture of me having just jumped and landed in a rice paddy. Look at the boots. Probably my 25th jump — an informed but imprudent decision.I was doing my own stunts in those days.
Scan those!My experiences are not life and death and, again, the reverse.My favourite was a really bright, 24 yo EE (good guy too) telling me that he ‘decided to take on the manufacturing role, ’cause how hard could it be…….”An uniformed decision that didn’t work out as well as jumping out of a plane!
Brinkmanship is not much dumber than the funded startup that knows ‘there (is) something great on the horizon, but we (don’t) know what or when’.It might be a good study to see how often brinksmanship comes up after a senior team member says ‘but we don’t know what or when’.I am not sure if you could data dump the returns on every startup where the CEO or senior team said that (I would be in that group, let’s be clear) but it is likely worse than Fred’s bridge loan group.How about this ‘bridge to reality’ story:Brought a private equity circle into a startup, through a lead investor that I knew. Both of us pretty green, I guess, at the time. I was 6 weeks into a job helping them figure out what was on the horizon and they had 6 days cash (not part of my diligence, at the time, apparently.)My investor suggests a bridge, as the seed funder was turning off the tap and making mad ape noises.A bridge seemed simple enough. It was a good product idea, being built well and in a reasonably large space. Investor would get them to the next month and then he would bring his entire circle in to close an A style round. They would treat Seed funder fairly (he would get punished for not participating, but not excessively) and move things forward.Seemed doable.First month goes by. No deal. Second month. Third month.When the investor cut the valuation by 60%, he told me “my circle of more senior investors is telling me that I am not reducing the valuation, they (the founders) are reducing it” (by showing that they were a weak team, as they left him totally exposed by not closing the deal).The circle was down to one other person (no surprise), a family member who stood by my investor’s judgement of the merit of the opportunity in the market, but also did not want a zero on the family score sheet.Lots of fun meetings in months 4,5,6……. to say the least.Personally, I find it is more fun to know what is on the horizon. More of a rising tide adrenaline rush, as opposed to a Hurricane Katrina……..
For your consideration: MBA Sundays.Awesome resource you’re building here, and I love it….but as a reader it’s just not exciting and relevant enough to match up to my TGIM! spirit.
the alliteration works though
You’re gonna let marketing hacks drive product development at AVC? 🙂
hey now – easy on the marketing hacks –
At least we can look forward to Fred’s post on Google’s announcement to buy Motorola tomorrow. 😉
Sunday’s are for Fred’s musings…..which I really like.I’ll be in Louisville tomorrow night.
Email me andy at andyswan…..com
Somehow, we have managed to finance our company entirely on bridge loans – but they were all bridge loans to big POs. In hindsight, that worked out great for us – we kept most of the equity in our firm and the bridge loans helped us cover burn to the next close. Of course, we were very fortunate to keep closing deals, so at this point we have repaid 100% of the loans we took and are now looking at several M&A opportunities – thanking G-d we didn’t take VC money…Love MBA Mondays, FYC – maybe dedicate a few posts to people development and good management practices (setting strategy, meeting objectives, etc.)
that is gutsy and i’m glad it worked outalways be closing!
You’d think that investors who grant bridge loans that make no economic sense do so because, as you say, it’s “the right thing to do”. Reality is that throwing good money after bad is actually a common psychological phenomenon called sunk cost fallacy: It’s “the phenomenon where people justify increased investment in a decision, based on the cumulative prior investment, despite new evidence suggesting that the cost, starting today, of continuing the decision outweighs the expected benefit.” (Wikipedia).
For any CEO considering a bridge loan understand that the terms of control by your investors you were funded under go away to the terms of the bridge loan. Remember, you are out of money, you need a lifeline, but your lenders can call the loan and let you drown. The lenders can force a change of control or recap the company to crush out existing shareholders, or many other bad things. A bridge loan is a last resort or the way I think of it a last gamble. Never run out of money is the first second and third rule of a CEO.
Edit: Oops, I totally skipped over “second” …
From an entrepreneur’s perspective I can say that a bridge loan, like a hanging, certainly focuses the mind.I have been on the “taking” end and even though it was the good kind (sale), the bridge loan should make you want the acquisition to happen as soon as is possible. First, because if the deal doesn’t go through you have to go raise more money which is another distraction after the already significant distraction of selling the business. Every minute not spent on product and customers is a momentum killer. Second, each dollar you take from the loan is costing you dearly at the time of sale. Everyone suffers other than the entity that is making the loan.So if you take a sale-related bridge loan take it in smaller tranches, manage your dollars VERY carefully until you are acquired and, above all else, get your deal done as fast as you reasonably can.
@mattstraz:disqus “From an entrepreneur’s perspective I can say that a bridge loan, like a hanging, certainly focuses the mind.”Haha, that’s excellent.Here’s a picture of a bridge loan that did not work out so well.
great comment, particularly the bit about time not spent on the product and customers
You got me thinking about bridges. Here are some real bridges I built before I got into the business of business.I learned everything I ever needed to succeed in business in places like this.This is my company getting ready to bridge the Imjin River in ROK.Note the section of floating bridge in the middle and the “raft” on the right side.I had just blasted out the underwater abutments using C4. I had a hell of a time swimming against the current.I was probably 25 years old and this was my junk.
I used to build the bridge in sections which was not the doctrine at the time. You were supposed to build the entire bridge and swing it into position but it was hell to get the measurements right, so I ignored the doctrine and built it in pieces. I got a damn good ass chewing for this until the Bn Cdr realized my guys had just set the record for the fastest crossing of the Imjin.
Then I finished off the raft and began to cross the tanks. We had seized the far shore in little rubber boats at dawn and were now getting ready to cross all the Division’s tanks which were on the way.This was the vanguard of the tanks. If the tanks arrive and the raft is not done, not good.This was only one hour from the beginning of the actual construction. Very quick.
Here’s the completed bridge — having crossed a couple of companies of tanks who were supposed to be wacking the NKs and expanding the bridgehead in anticipation of hundreds of tanks arriving in a speeding column.In about 5 minutes the first tanks would arrive and without hitting the brake would cross this bridge and spread out into the countryside looking for trouble.You can see now I cheated on the measurements, I built an approach causeway out to the bridge and closed the gap w/ rock not bridging. This was the key to getting it done fast.This was not the doctrine then but quickly became the theater doctrine because of how well it worked. This was a suggestion of a very salty Sergeant who I had the wisdom to listen to. I got all the credit but he was the brains.I got him an “impact” Bronze Star for his wisdom. He was great.
Here are some dipshits who did not listen when I told them the bridges leading up to the bridge site were not well built and to take the bypasses. This tank tried to cross the bridge and rolled over killing a couple of guys trapped under the tank.This is the kind of stupid stuff that happens when people do not listen.I ultimately blew this bridge up and rebuilt it to be able to cross two tanks simultaneously. During the heavy rains this crossing was 20′ deep in water.
Everything I ever learned that has been useful in business I learned in experiences like this. About 3 years later I was let loose on the world with an MBA in finance from the GI Bill. It’s been a hell of a ride.Here’s a picture of the raw material. Thanks for indulging me.Hee haw!
(Last message doesn’t allow replies)Thanks so much for sharing. Great to hear how people evolved. 🙂
If you can figure out a “bridge” to keep Texas Pols in the state, please let us all know.
i’m going to show my dad all these pictures and comments. he’s coming to visit this weekend
Would a startup want to get a bridge loan from the same VC that will be leading the next round? It seems like if the VC knows they will be able to close the round within a certain time period, a bridge loan could be a secure way to get the company there before they run out of cash.
that is very rare. most VCs only want to be in the deal if they can be in for the full amount and under the ful terms they negotiated for
Could some sort of start-up want to be some sort of connect personal loan on the similar VC which is to be foremost your next around? It appears as if should the VC appreciates many people is able to in close proximity this around just a a number of phase, some sort of connect personal loan is a safeguarded technique to discover the corporation at this time there previous to many people be depleted connected with dollars.
When it comes to Bridge Rounds its not really my story, just what I’ve seen. One was a company called ReturnCentral where I sat on the board. They took a bridge round and sold to Manhattan Associates. The terms were onerous. They sold for much less than what was put in. When they sold management demanded a carve out. There was huge bitterness. I was in the middle. Investors wanted management to adhere to all terms, management who orchestrated the sale, thought that terms are what you get at a period of time. They felt that had terrible terms crammed down to them when they really had no choice and now the shoe was on the other foot. Management did end up with what I thought was a reasonable carve out and investors were pissed. I think the investors got over it when they saw many no returns from other bridged companies. That was during the first internet boom.The other was at Essential Technologies to whom I had sold EnviroMetrics and held a ton of paper (put that down as REALLY expensive tuition). I had bitterly disagreed with managment after the buyout, and my prediction for a nuclear winter for enterprise sales for Y2K was proved right. If they had held on Essential had the best emergency preparedness software and 9/11 would have been a boon. When this deal got done I immediately resigned from the board and wept over my worthless stock certificates which I had to show for a lot of work (although the ride was very fun). The company augured it in even harder than I predicted planting a very ugly hole in the ground. Some of the best people I know worked with me at EnviroMetrics and have gone on to do great things at tons of companies big and small. The EnviroMetrics code base was bought at auction by a startup and eventually was sold to IHS for $60M. I didn’t see a penny.The rest I’ve seen from other CEO friends, but I won’t comment on that because its hearsay, but nobody was happy.The rest is on my blog.
somebody here BAN this link spammer, eh?…sigh….idiots….
I was trying to understand what this is 🙂