Bridge financing definition

Bridge financing is a temporary financing solution, used to cover a company’s short-term costs until it secures long-term financing options. Investment banks or venture capital firms usually provide bridge financing in the form of short-term loans or equity investment.

In this article we will learn what bridge financing means. We will also study how bridge financing works and look at some bridge financing examples.

What is bridge financing?

Bridge financing is used to bridge the gap between a company’s need to meet short-term capital requirements and an expected forthcoming inflow of funds.

Since a company looking to secure bridge financing requires funds immediately, this type of financing can be particularly expensive. Bridge financing loans are not straightforward and lenders often demand extra collateral to finance such short-term loans.

Bridge financing is typically used by corporations before going public, or prior to a major equity transaction. Bridge financing is needed to cover additional expenses, such as the underwriting costs and stock exchange fees which are incurred during such transactions.

Types of bridge financing

The different types of bridge financing are:

• Debt bridge financing - This type of bridge financing requires a company to take out a high-interest, short-term loan known as a bridge loan. Companies need to be diligent when taking such loans, so that the high interest rates do not exacerbate the financial struggles of the company in the long run. 

• Equity bridge financing - If a company chooses not to take on debt, it can choose to sell equity to venture capital firms or investment banks in exchange for funding.

• Initial public offer (IPO) financing - Bridge financing is used to cover the expenses related to an IPO, such as underwriting costs and stock exchange fees. The required funds are usually provided by the investment bank that underwrites the IPO. The eventual inflow of funds from the equity sale to the public will be used to pay back the loans. The investment bank providing the funds can also be offered IPO shares at discounted prices.

Bridge financing examples

How does bridge financing work? Bridge financing can be complex, and can include a number of provisions.

Consider a manufacturing company that needs $10m to complete the development of its new factory, which is expected to be profitable, increase its production efficiencies and help it clear its order backlog faster. A venture capital firm agrees to provide the loan at an interest rate of 22% per year and requires the company to pay back the debt within one year. 

The venture capital firm may also insert a convertibility clause, which gives it the option to convert a certain amount of the loan to an equity stake in the company at an agreed stock price.

A simpler example of a bridge loan would be a company that has taken a tranched loan of $1m from a bank. Since the loan is broken into tranches, the company will only receive the money at the end of the next quarter. The company can apply for a short-term loan to cover its working capital for the time being.