Bridge financing: What it is and how to use it

The startup world is notorious for its fast-paced and unpredictable environment, but that doesn’t mesh well with financial planning. However, your startup can’t afford to take a month off to apply for a traditional loan or petition venture capitalists—it needs to sustain momentum and keep the pedal to the floor.

Enter bridge financing: a financial tool that helps you weather everything from short-term cash crunches to gaps before major funding rounds. This sometimes forgotten form of financing can be a lifesaver for entrepreneurs, but it’s a double-edged sword if wielded incorrectly.

Below, we’ll walk you through everything you need to know about bridge financing to leverage it safely and strategically for your growing startup.

What is bridge financing?

Bridge financing (often called a bridge loan) is a short-term financial solution designed to bridge the gap between immediate funding needs and long-term financial solutions. It’s a temporary arrangement providing quick access to cash for businesses facing immediate financial demands.

Here are a few key characteristics of bridge loans that make them unique:

• Short-term nature: Unlike traditional loans and permanent financing that might span several years, bridge financing is designed for short durations, addressing immediate needs.
• Collateral-based: Most bridge loans are secured, meaning they require collateral. This could be assets like real estate, inventory, or accounts receivable.
• Higher interest rates: Given their short-term and often urgent nature, bridge loans typically have higher interest rates than standard loans.
• Flexible terms: Lenders often provide more flexible terms for bridge financing since they understand that startups are navigating transitional phases.
• Quick approval: One of the main advantages of bridge financing is the speed of approval. Startups can often secure funds within days, making it ideal for urgent needs.
• Equity bridge financing: A specific type of bridge financing where sponsors receive a short-term loan to fund the equity component of a project or investment, which is then repaid from the proceeds of a subsequent equity issuance or capital call from investors.

Bridge financing provides the necessary capital to cover immediate operational costs, from salaries and rent to unexpected expenses. Whether it’s a competitor’s move, regulatory changes, or an unforeseen growth opportunity, bridge financing gives your startup the funds to respond quickly.

“While bridge rounds often carry negative connotations—such as implying the company is in financial trouble—that is not always the case. Bridge rounds might also provide an interim cash infusion to capitalize on rapid growth or prepare for an IPO,” says the team at AngelList. “Bridge rounds are often not ideal. But they might be the difference between a failed startup and one that survives to fight another day.”

When (and how) to use bridge financing

Bridge financing is a powerful solution but best used at a particular time and place. Here are some ways to make a bridge loan work to support your growing startup:

Pending larger investments

Startups often find themselves in a situation where they’ve secured a commitment for a significant funding round, but the funds might take time to materialize. During this waiting period, operational costs don’t stop—you still have salaries, rent, and other expenses.

Bridge financing serves as a stop-gap solution, providing the necessary funds to keep your startup operational and maintaining momentum while the larger investment comes through or your company secures permanent financing.

Operational expansion

The startup journey is filled with unforeseen challenges and opportunities. Equipment breaks down, software requires immediate upgrades and golden chances to hire key team members come out of nowhere.

When time is of the essence, you can’t wait around on traditional financing methods. Bridge loans provide a quick, short-term financing solution, helping you patch the problem or seize the opportunity.

Market opportunities

The startup business landscape is dynamic. A competitor’s misstep, a sudden market demand, or a chance for a strategic partnership or acquisition can emerge unexpectedly.

These opportunities are often time-sensitive. A bridge loan empowers your startup to act swiftly, capitalizing on these market opportunities without being held back by financial constraints.

Product development and innovation

In the tech-driven world, staying ahead of the curve is non-negotiable. Your startup might find a need to fast-track a product development to beat competitors or to satisfy newly identified market demand, but research, development, and innovation cost money.

Bridge loans provide the necessary funds to accelerate these processes, helping you stay on top of the market without skipping a beat.

Debt obligations

A bridge loan probably isn’t your first debt-financing rodeo. You might already have other loans with payment deadlines looming, whether that’s business credit cards, lines of credit, or traditional loans.

A delay in expected revenue or another funding source can put your startup at risk of defaulting on these obligations. A bridge loan offers a short-term solution, helping your startup maintain its financial credibility while addressing debt obligations.

Inventory and supply chain demands

Inventory management is mission-critical for e-commerce, retail, or manufacturing startups. Market demands fluctuate, or supply chain disruptions might occur due to external factors. Bridge loans can help your startup manage these demands, ensuring consistent operations and customer satisfaction.

Pros and cons of bridge financing

Navigating the financial challenges of a startup often requires a blend of traditional and innovative solutions. While we’d all love angel investors to swoop in and solve all our financing needs, that’s far from the reality.

Bridge loans stand out as a fast, reliable financing solution, but every rose has its thorns. Below, we’ll help you understand the advantages and disadvantages of bridge financing to help you make informed decisions that align with your growth trajectory and financial health.

Advantages of bridge financing

We’ve been talking up bridge loans for a while now, but it’s time to get into the nitty-gritty details behind why this can be an excellent financing tool for startups:

1. Quick access to funds: Speed is a hallmark of bridge financing, providing startups with funds in a matter of days to address urgent needs.
2. Flexibility: Lenders often tailor terms to suit a startup’s unique situation, offering more flexibility than traditional loans.
3. Short-term commitment: The temporary nature of bridge loans means your startup isn’t tied down to long term financing obligations.
4. Potential for less dilution: Convertible notes in bridge financing can lead to favorable equity terms in subsequent funding rounds, minimizing dilution.
5. Builds financial credibility: Securing and repaying bridge financing can boost your startup’s financial reputation, aiding in future financial endeavors.

Disadvantages and risks of bridge financing

Bridge loans aren’t all milk and cookies—they have a few downsides that you’ll need to consider:

1. Higher interest rates: The urgency and short-term nature of bridge loan financing often translate to a higher interest rate.
2. Risk of increased debt: If anticipated funding or revenue falls through, repaying the bridge loan can become a challenge, escalating debt.
3. Collateral requirements: Bridge financing often requires collateral, putting startup assets at potential risk.
4. Potential for unfavorable terms: Desperate situations might lead lenders to impose less-than-ideal terms on startups.
5. Risk of over-reliance: Continual dependence on bridge financing without addressing core financial issues can trap startups in a debt cycle.

“Nobody capitalizes their business planning for a ‘bridge’ round, so the general assumption is that the company must have significantly underperformed expectations to have arrived in this spot,” says the team at SaaS Capital.

Alternatives to a bridge loan

Bridges loans have advantages, but that doesn’t mean they’re the perfect financing solution. The higher interest rates and dependence on debt can threaten your startup, limiting your leverage and stunting long-term growth.

In some situations, bridge financing won’t be right for your business. Ideally, you’ll want to secure funds from a venture capital firm or angel investor, but that’s not always an option.

When the cons of bridge loans outweigh the pros, consider these alternatives:

• Invoice financing: Businesses can sell their receivables (invoices) to a third party (a factor) at a discount. This provides immediate cash flow.
• Line of credit: A flexible option where businesses can draw funds up to a certain limit and pay interest only on the amount they use. It’s pre-approved, so funds can be accessed immediately when needed.
• Merchant cash advance (MCA): Businesses receive a lump sum in exchange for a percentage of future credit card sales. It’s a quick way to get cash, especially for businesses with strong credit card sales.
• Short-term loan: Some lenders specialize in short-term loans that can be approved and disbursed quickly, although often at higher interest rates.
• Crowdfunding: Some crowdfunding platforms, like Indiegogo’s “InDemand,” allow businesses to access funds as they’re raised rather than waiting until the end of the campaign.

Scale your startup with DigitalOcean

While bridge financing and its alternatives offer quick solutions to immediate financial challenges, the foundation of a startup’s success lies in its operational efficiency, scalability, and the robustness of its technological infrastructure.

That’s where we come in. We understand the unique challenges faced by startups.

With our suite of cloud solutions tailored for growing businesses, DigitalOcean ensures your startup has the technological backbone it needs to scale seamlessly. From easy-to-deploy droplets to managed databases and Kubernetes solutions, DigitalOcean provides tools that empower startups to handle increased traffic, expand their user base, and launch new features with confidence.

Curious about what it’ll cost you? Check out our transparent, predictable pricing.