Bridge Financing: What It Is and How To Use It | DigitalOcean (2024)

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.

Bridge Financing: What It Is and How To Use It | DigitalOcean (2024)

FAQs

Bridge Financing: What It Is and How To Use It | DigitalOcean? ›

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.

What is bridge financing in simple terms? ›

Bridge financing or bridge loans are short-term or interim loans that serve the immediate requirements of a business until a long-term loan is secured. It bridges the gap of securing finances with the immediate cash flow requirements of the company.

What is a bridge loan and how do they work? ›

A bridge loan — in some cases referred to as a hard money loan — is a short-term loan designed to provide financing during a transitionary period, such as moving from one house to another. Bridge loans are often secured by your current home as collateral, just like mortgages, home equity loans and HELOCs.

How do you use a bridging loan? ›

They can be used to 'bridge the gap' if you need to buy one property before selling another. Unlike mortgages, bridging loans can be arranged quickly if speed is important. However, bridging loans are a secured loan, meaning that you have to secure an asset against them, usually a property or properties.

How does bridge funding work? ›

Bridge loans are typically short-term in nature and involve high interest. Equity bridge financing requires giving up a stake in the company in exchange for financing. IPO bridge financing is used by companies going public. The financing covers the IPO costs and then is paid off when the company goes public.

Is it a good idea to get a bridge loan? ›

While bridge loans can be a strategic way to buy a home while selling your current property or to handle business or investment transactions, they have high interest rates, short repayment periods and other drawbacks.

What are the risks of bridge financing? ›

These include host-country investment risks, such as weak and unstable business environments, limited ability to repay funds, and political instability; the risk of new barriers to trade and investment; risks posed by geopolitical competition with the United States; and the risk of hollowing out domestic industries ...

How do you pay back a bridge loan? ›

You can pay back the bridge loan with the proceeds once your current home sells. A Bridge loan can afford you the freedom to move on your own terms and secure a new house when you need to, without having to wait for your old house to sell if you need to move within a specific timeframe.

How long can you use a bridge loan? ›

Bridge loans in California allow a property owner to borrow against their California real estate in order to help purchase their next property. California bridge loans are short-term and typically written for up to 11 months.

Can you pay off a bridging loan early? ›

A bridging loan is a flexible short-term loan, and because it's flexible, most bridging loans do not charge exit fees if you repay early. A bridging loan charges interest for as long as it has not been repaid. The main reason to repay the loan as soon as possible is to save on interest payments.

Is a bridging loan worth it? ›

Bridging loans are a way to borrow a large amount of money for a short amount of time. They're most commonly used to 'bridge the gap' when buying property – for example, if you need to complete on a purchase before you've sold your current home. While they can be useful, they're high risk if things don't work out.

Which banks do bridging loans? ›

Banks That Offer Bridge Loans
  • NatWest.
  • HSBC.
  • Bank of Scotland.
  • Barclays.
  • Halifax.
  • Lloyds.
  • RBS.
  • Santander.

What is the typical interest rate on a bridging loan? ›

Bridging loan interest rates are typically between 0.5% and 2% per month. The exact rate you get will depend on: The type of property you're buying.

What went wrong with bridging finance? ›

Bridging and the Sharpes, once considered the invincible masters of risk, were accused of fraud, misappropriated funds, self-dealing and misleading investigators. Investors stood to lose more than $1.6 billion.

What is bridge loan in simple words? ›

A bridge loan is a short-term loan used to bridge the gap between buying a home and selling your previous one. Sometimes you want to buy before you sell, meaning you don't have the profit from the sale to apply to your new home's down payment.

What is an example of a bridge finance? ›

What is an example of bridge finance? Bridge finance is a short-term funding solution facilitating immediate financial needs before a more permanent arrangement. For instance, when buying a new home before selling the existing one, a bridge loan covers the transition.

What is an example of a financial bridge? ›

For example, if a company's revenue increases from $100,000 to $110,000, the revenue bridge chart would show the breakdown of how much of that increase is due to an increase in the number of units sold (volume impact), a change in the mix of products sold (mix impact), a change in the average price of the products sold ...

What is the difference between a bridge loan and a loan? ›

The main difference is that a bridge loan is short term, while a conventional loan is long term.

Do bridge loans have higher interest rates? ›

Bridge loans typically have higher interest rates than traditional loans. Also, if you are waiting to sell your home and still have a mortgage, you'll have to make payments on both loans.

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