It's no secret that start-ups often require an infusion of funds in order to finance their operations in general and reach a meaningful milestone, in particular. There are various types of funding and financing out there, be it debt or equity.
In this post, we'll take a closer look at a bridge financing and what it can do for your start-up.
Bridge financing can be a great way to obtain much-needed funds, in a relatively short period of time. In general, this type of financing is supposed to be easier to obtain but the lengthy negotiations can sometimes result in quite the opposite. Be sure to carefully consider all of your options before moving forward.
Bridge financing in the form of a traditional loan is not easy to obtain without providing the lenders with personal guarantees of the founders.
Convertible loan agreements will not require personal guarantees by the founder and will be typically used to fund a start-up's operations until it can secure more long-term funding. This type of financing is usually easier to obtain than traditional loans, but the terms are often less favorable to your company. Convertible loans may either be converted into equity in a future round or repaid with funds from a subsequent financing round or upon the occurrence of an agreed upon due date.
For many years it was popular to raise bridge financing through a convertible loan agreement (CLA), which is a loan that can be converted into equity at a later date. The CLA gives the lender the option to convert the loan into equity, usually at a discount and with a cap on valuation, as part of a subsequent equity financing round. Although a CLA enables a company to reduce lengthy contract negotiations and valuation determinations, it does have drawbacks such as being an interest bearing loan with a repayment date and conversion at what can be a large discount on the price per share at the next financing round or a low cap on valuation. While CLA's can be straightforward, at times, it can result in lengthy negotiations surrounding the lender's rights such as the interest rate, discount rates, caps on valuation and conversion rights (customarily dependent on an agreed upon qualified financing negotiated definition) and sometimes a due date if a qualified financing does not take place until a certain date.
The YCombinator Accelerator created a basic set of short documents entitled simple agreement for future equity (or SAFE). A SAFE is an investment contract that provides for the issuance of equity at a later date, typically when the company raises additional funding. The funding remitted under a SAFE is not a debt and the start-up will never have to repay it. The rules are clear – for conversion purposes they may include a discount or a cap on valuation, or both and they may be based on a pre-money or post-money valuation. Use of a SAFE is less time-consuming than a CLA and tremendously lowers legal costs.
When using a YCombinator template make sure you understand the definitions – they are the key to understanding this document.
- bridge financing is a type of short-term loan that is typically used to fund a start-up's operations until it can secure more long-term funding.
- Convertible bridge loans have pros and cons but at the end of the day they are loans and have to be repaid in certain circumstances.
- bridge loans are typically repaid with funds from a subsequent round of financing.
- the simple agreement for future equity (or SAFE) is an investment contract that provides for the issuance of equity at a later date, typically when the company raises additional funding.
- use of a SAFE is less time-consuming than a CLA and lowers legal costs.