Bridge Round

What is a bridge round?

Bridge round (German Zwischenrunde, Brückenrunde) refers to a financing with which a startup or growth company bridges the time between two equity rounds with a fixed price per share. In English-language venture capital, bridge funding is also used. The situation between seed and Series A or between Series A and Series B is typical. In Germany, it is usually implemented through a convertible loan, less often as a small capital increase on the terms of the last round.

The bridge round is a sub-type of bridge financing (bridge financing), which also covers debt capital and bridges in the sale process. The providers are predominantly the existing investors, whose pre-emptive rights (pre-emptive rights), that is, the right to take part proportionately in new financings, are regularly affected. It is documented in a convertible loan agreement or in an investment agreement with a capital increase. The consents that the shareholders' agreement requires for new financings are added.

Occasion and aim of a bridge round

A bridge round finances a specific stretch of time. This is usually the time until a milestone that makes the next round viable, such as a revenue level, a product launch or an approval. Sometimes it bridges only the time until the closing of a round that is already under way. From the providers' point of view, what matters is whether this milestone can be reached with the amount and whether investors in the follow-on round will see it as the basis for a higher valuation.

Two situations should be distinguished. In the favourable case, the company develops as planned, and the bridge round postpones the follow-on round to a point in time with better key figures. In the unfavourable case, targets were missed, and the existing investors provide financing to protect their existing holding. Terms and perception in the market differ accordingly.

Structure and terms of the bridge round

• Instrument: usually a convertible loan with a discount and valuation cap, where a follow-on round is imminent sometimes with a discount only. A priced capital increase is cumbersome for small amounts but fixes the price immediately.
• Terms: Discount, interest and cap reflect the risk. The more difficult the situation, the more likely it is that higher discounts, lower caps or option rights over shares are added, on whose exercise the holder pays a price fixed in advance.
• Participation of existing investors: usually pro rata according to their existing share. In difficult situations, disadvantages for non-participating investors are agreed (pay-to-play) in order to achieve broad participation.
• Term: sized by the time until the milestone and until the closing of the follow-on round, with a reserve.

In tense situations, bridge rounds sometimes contain preferential terms for the new money, such as a multiple liquidation preference. Such a preference is not a guaranteed return. It determines who is served first and in what amount from the proceeds in a sale, and it has no effect to the extent that the proceeds do not suffice. At middling sale prices, however, it can direct a large part of the proceeds to the new money.

Shareholder loans and insolvency law

If existing shareholders provide the loan, it is a shareholder loan. In insolvency, such loans are in principle subordinated, that is, they are served only after ordinary creditors (Section 39(1) no. 5 of the German Insolvency Code, Insolvenzordnung, InsO). Repayments in the last year before the insolvency filing can be challenged (Section 135(1) no. 2 InsO). Exempt, among others, are non-managing shareholders holding at most 10% of the share capital (Section 39(5) InsO), which may apply to smaller existing investors. For the over-indebtedness test, this statutory subordination is not sufficient; only an agreed qualified subordination (Rangrücktritt) takes the loan out of the over-indebtedness statement, the comparison of assets and liabilities. A bridge round in a difficult situation therefore requires, besides the financing, an up-to-date going-concern forecast by the management.

Signalling effect of the bridge round for the follow-on round

Investors in the follow-on round ask why a bridge round was necessary, who took part and what was achieved with the money. If the most important existing investor did not take part, they regularly read this as a warning sign. Conversely, a bridge round with which an announced milestone was reached strengthens the company's negotiating position.

If the cap price of the bridge round, that is, the valuation cap per share, lies below the price per share of the last round, the bridge round acts economically like a down round (down round). Whether this triggers the anti-dilution protection of earlier investors depends on its clause; some capture conversions as well, others exclude them.

Worked example: bridge round as a convertible loan or capital increase

After its last round, a GmbH (German limited liability company) has 80,000 shares on a fully diluted basis, that is, including the employee programme; the price of that round was EUR 50 per share. The monthly net cash outflow, that is, expenses less income, is EUR 100,000, and the existing investors provide EUR 1 million for ten months, for simplicity without a reserve. The choice is between a capital increase at the previous price or a convertible loan with 6% interest per year and a 20% discount. The valuation cap of the convertible loan is EUR 6 million pre-round, based on the 80,000 shares. The follow-on round comes about after ten months.

• Capital increase at the previous price: 1,000,000 / 50 = 20,000 new shares, regardless of the later round price
• Conversion amount after ten months: 1,000,000 + 1,000,000 × 6% × 10 / 12 = EUR 1,050,000; cap price: 6,000,000 / 80,000 = EUR 75
• Follow-on round at EUR 120: discount price 120 × 0.8 = EUR 96, the cap price of EUR 75 is lower; conversion shares 1,050,000 / 75 = 14,000
• Follow-on round at EUR 87.50: discount price 87.50 × 0.8 = EUR 70, lower than EUR 75; conversion shares 1,050,000 / 70 = 15,000
• Follow-on round at EUR 60: discount price 60 × 0.8 = EUR 48; conversion shares 1,050,000 / 48 = 21,875
• Break-even with the capital increase: 1,050,000 / 20,000 = EUR 52.50 conversion price, that is, a round price of 52.50 / 0.8 = EUR 65.625

If the company develops well, the convertible loan is more favourable for the founders: the conversion price rises with the round price up to the cap of EUR 75 and then lies above the old price of EUR 50, so that fewer new shares arise. If the follow-on round stays below roughly EUR 65.63 per share, this reverses. The discount then gives the providers of the bridge round more shares than they would have received with a capital increase at the old price. The choice of instrument thus also expresses how confident the participants are of reaching the milestone.

Distinction: bridge round, bridge financing, extension and down round

• Bridge financing: the umbrella term for any bridging financing, including with debt capital or in the sale process. The bridge round is the form between two equity rounds.
• Extension of the last round: a further capital increase on the terms of the last round. It is often understood as a variant of the bridge round but fixes a set price.
• Down round: a round at a lower price per share than the previous one. A bridge round through a convertible loan is not a down round but can have a similar effect through a low cap.
• Follow-on investment: the follow-up investment of an existing investor in a later round. Taking part in a bridge round is a special case of this.

Common mistakes

• Amount without a milestone. A bridge round that merely covers running costs for a few months, without financing progress that is relevant to investors, leads back to the same situation.
• Bridge too short. If the money does not last until the closing of the follow-on round, including a reserve, the next search for capital starts under greater time pressure.
• Costs not adjusted. In a bridge round, investors expect a plan that aligns cash outflow with the milestone; an unchanged cost structure weakens credibility.
• Preferential terms not worked through. Multiple preferences or low caps are accepted under time pressure without quantifying their effect on later proceeds and rounds.
• Consents and pre-emptive rights bypassed. Consent reservations and pre-emptive rights under the shareholders' agreement also apply to bridge rounds; if they are bypassed, the financing is open to challenge.

Frequently asked questions

Is a bridge round a down round?

Not as a matter of principle. Through a convertible loan, no new price per share is initially fixed. If the cap price lies below the price per share of the last round, however, the bridge round acts in a similar way economically.

How long should a bridge round last?

Until the targeted milestone and the closing of the follow-on round, plus a reserve. A bridge that carries only a few months leaves hardly any room for demonstrable progress.

Must all existing investors take part?

No; as a rule there is no legal obligation to do so. New investors do, however, pay attention to whether the large existing investors go along; pay-to-play provisions are therefore meant to secure broad participation.

How is a bridge round valued?

Usually not expressly at all. A convertible loan postpones the valuation to the follow-on round; the valuation cap merely sets a maximum price for conversion. If the bridge round is implemented as a capital increase, the price of the last round generally applies, so that no new valuation is negotiated either.

Do new investors also take part in bridge rounds?

Less often. New investors generally prefer a priced round in which they negotiate valuation and rights in full. They are more likely to take part in bridge rounds if this gives them access to the follow-on round, for example as a future lead investor who leads the follow-on round.

The Roemer Capital view

If a bridge round is on the table, we first check whether the objective holds. This includes which milestone can be reached with the amount, how far the runway of liquid funds is extended and what valuation is realistic for the follow-on round. The terms that we help negotiate with the existing investors build on this, from discount and cap to the term.

For the follow-on round, we prepare the bridge round so that new investors can follow the occasion, use and result, including the conversion shares in the pro forma cap table. The contracts are drafted by the company's law firm.