Bridge Financing

What is bridge financing?

Bridge financing (German Überbrückungsfinanzierung) refers to financing that covers a time-limited capital need until a foreseeable event, from which the funds are later replaced or repaid. Such events include an equity round, the closing of a company sale, long-term follow-on financing or the inflow of committed public funding. The principle is familiar to anyone who buys a house before the old flat has been sold: the bank prefinances the purchase price for a few months until the sale proceeds arrive. Also in use are the terms bridging loan and bridge loan, the latter for the form of loan.

The term is broader than the bridge round, with which growth companies bridge the time between two equity rounds. Bridges exist as equity, as instruments close to equity such as the convertible loan, and as pure debt capital. The providers are existing shareholders, investors, banks, providers of venture debt or, in a sale process, also the buyer. The bridge is governed by the relevant loan or investment agreement; in a company acquisition, provisions in the purchase agreement are added.

Occasions for bridge financing

• Between two funding rounds: Liquidity does not last until the next round closes, for example because milestones are reached later or the process takes longer. The existing investors then usually provide the bridge.
• Between signing and closing: In a company sale, weeks or months often lie between signing and closing, for example because of regulatory clearances. If the target company needs liquidity during this time, shareholder loans from the sellers, a loan from the buyer or bank financing come into consideration.
• Purchase price financing on the buyer side: An acquirer first finances the purchase price with a short-term bridge loan, which is later replaced by a bond, a promissory note loan (Schuldscheindarlehen) or a capital increase.
• Until committed funds arrive: Approved public funding following a grant award notice or an agreed later tranche of a round is prefinanced. Providers often have the expected inflow assigned to them as collateral, to the extent the funding conditions allow.

In a sale process, it should be noted that between signing and closing the purchase agreement regularly obliges the management to continue in the ordinary course of business (ordinary course of business). New financial liabilities then need the buyer's consent.

Instruments and costs of a bridge financing

• Convertible loan: the usual instrument between two rounds. It postpones the valuation question to the next round and compensates the risk through a discount and a valuation cap.
• Capital increase on previous terms: an extension of the last round at the price then applied. It creates equity immediately but requires notarisation and registration.
• Shareholder loan: in insolvency in principle subordinated (Section 39(1) no. 5 of the German Insolvency Code, Insolvenzordnung, InsO). It drops out of the over-indebtedness test only if a qualified subordination agreement (Rangrücktritt) has been agreed, that is, the lender expressly ranks behind all other creditors.
• Bank loan: requires creditworthiness and usually collateral and comes into consideration mainly for companies with stable cash flow.
• Venture debt: loans for fast-growing companies that are serviced with interest and repayments on an ongoing basis and are often combined with option rights over shares.

Such an option right (warrant) is the right to acquire or subscribe for shares later at a price fixed in advance. It is neither a share nor a free extra, because on exercise the holder pays the agreed price. Its size is often measured as a percentage of the loan amount (warrant coverage). In a GmbH (German limited liability company), such a right can be granted only under the law of obligations, for example as a promise of a future capital increase with the shareholders' cooperation or as a virtual right with a payment claim.

Bridges are granted in a phase of heightened uncertainty. The terms are therefore often more favourable for the providers than in a regular round: higher discounts or interest, lower caps, collateral or additional rights.

Formula: Bridge amount = monthly net cash outflow × (months until the target event + reserve months) minus available liquid funds; interest costs = bridge amount × interest rate × term in months / 12

Risks and signalling effect of bridge financing

With every bridge, what matters first is whether the target event is attainable. Financing without a reliable path to a round, sale or refinancing merely extends the runway without changing the situation; in English usage, this is called a bridge to nowhere. Providers therefore examine the occasion and use of the funds, the milestone that is to be reached with them and the measures to reduce the burn rate.

How a bridge is perceived depends on these circumstances, not on its label. If important existing investors do not participate, new investors read this as a warning sign. In a crisis, further requirements are added: providers then often demand a restructuring plan, and the management must keep the duties to file for insolvency in view.

Bridge financing in due diligence and purchase price

In due diligence, buyers and investors examine repayment and change-of-control clauses, collateral, conversion rights, option rights and consent reservations for every bridging instrument. In a company acquisition, bridge loans are financial liabilities. They are deducted in the step from enterprise value, the value of the operating business regardless of its financing, to the purchase price for the equity (equity value).

Who economically bears the costs of a bridge between signing and closing depends on the purchase price mechanism. With a settlement as of the closing date (completion accounts), any additional debt reduces the purchase price. With the locked box mechanism, the purchase price is fixed; payments to the sellers after the reference date, such as interest and repayments on their loan, must then be agreed as permitted leakage.

Worked example: bridge financing between signing and closing

A software company has signed a company purchase agreement. Closing depends on a regulatory clearance and is expected in four months. The purchase price results from an enterprise value of EUR 18 million less net financial liabilities at closing, that is, financial debt less liquid funds. The company has EUR 500,000 of liquid funds, no financial liabilities and a monthly net cash outflow of EUR 200,000. With the buyer's consent, the sellers grant a shareholder loan at 6% interest per year, which is repaid at closing.

• Need until closing: 4 × 200,000 = EUR 800,000; reserve for two months of delay: EUR 400,000; together EUR 1.2 million
• Bridge amount: 1,200,000 minus 500,000 available funds = EUR 700,000
• Interest with closing after four months: 700,000 × 6% × 4 / 12 = EUR 14,000; repayment amount EUR 714,000
• Liquid funds at closing: 500,000 + 700,000 minus 800,000 = EUR 400,000
• Net financial liabilities at closing: 714,000 minus 400,000 = EUR 314,000; purchase price for the equity: 18,000,000 minus 314,000 = EUR 17,686,000
• Inflow to the sellers: 17,686,000 + 714,000 loan repayment = EUR 18,400,000; less the EUR 700,000 paid in, net EUR 17,700,000

At signing, the purchase price for the equity would have been EUR 18.5 million, enterprise value plus liquid funds. The difference of EUR 800,000 from the net proceeds corresponds to the cash outflow until closing, which, under completion accounts, the sellers bear. The interest does flow to them but reduces the purchase price by the same amount. With a locked box with a reference date before signing, by contrast, the cash outflow would economically lie with the buyer.

Distinction: bridge financing, bridge round, venture debt, mezzanine

• Bridge round: the interim round between two equity rounds of a growth company, usually through convertible loans from existing investors. It is a sub-type of bridge financing.
• Venture debt: a stand-alone debt instrument with a term of several years and repayment. It can form a bridge but is often used independently of a target event.
• Vendor loan: the deferral of part of the purchase price by the seller. It finances the acquisition, not the time until an event.
• Mezzanine capital: subordinated, equity-like financing with a longer term that supplements the capital structure on a lasting basis rather than bridging a gap.

Common mistakes

• No reliable target event. A bridge whose replacement is not foreseeable postpones the problem and weakens the negotiating position for the next financing.
• Sized too tightly. Without a reserve for delays, a bridge turns into a series of short-term top-up financings.
• Consents overlooked. Shareholders' agreements, purchase agreements and existing loan agreements often require the consent of investors, the buyer or banks for new financing.
• Option rights wrongly classified. A warrant is a cost component of the financing and dilutes on exercise; it belongs in the pro forma calculation of the cap table.
• Purchase price effect not considered. Bridge loans in a sale process reduce the purchase price as financial liabilities or, with a locked box, must be regulated as permitted leakage.
• Insolvency law ignored. In a tense situation, a bridge does not replace the management's ongoing testing for illiquidity and over-indebtedness.

Frequently asked questions

Is bridge financing always a convertible loan?

No. Between two equity rounds, the convertible loan is common, but bridges also exist as a capital increase, shareholder loan, bank loan or venture debt. In a company acquisition, they are usually loans.

How long should a bridge last?

Until the target event plus a reserve. Before a funding round, this covers the time until the milestones that investors want to see and the financing process itself. In a sale, it is the time until closing, including possible delays in clearances.

What does a bridge financing cost?

That depends on the instrument. For loans, the costs consist of interest, fees and, where applicable, collateral; for venture debt, additionally of option rights. For the convertible loan, they arise mainly as dilution: discount and cap determine how many shares the provider receives later. For a comparison, all components are converted into euros or into shares given up.

Does a bridge need the investors' consent?

Often yes. Shareholders' agreements regularly contain consent reservations for taking on financial liabilities and for new shares or convertible instruments. In a sale process, the buyer's consent under the purchase agreement is added.

Who typically provides a bridge financing?

Usually providers who already know the company: existing shareholders and investors and, in a sale process, also sellers or buyers. External providers participate more readily if the target event is contractually secured, for example by a signed purchase agreement or a grant award notice.

The Roemer Capital view

In a company sale, we plan liquidity up to the expected closing, including a reserve. A sale process takes 6 to 12 months, and clearances can postpone closing. If a bridging need emerges, we raise it early in the negotiation: who finances, how the bridge is treated in the purchase price mechanism and which consents are needed.

In funding mandates, the aim is the reverse: to avoid a bridge wherever possible. A company that enters the process with a runway of 12 to 18 months negotiates the round without time pressure. If a bridge is nevertheless needed, we work through the need and the costs with the company before conversations with providers begin.