Why It’s a Bad Idea to Ask for a Bridge Loan
November 26, 2018
Once a week or so a company will reach out to us looking for “bridge financing” that will carry them to their next funding event. In a way, all financings are bridge financings to some future event. However, the specific request for a short-term bridge loan carries with it unique challenges. I honestly believe many of these companies think bridge financings are a standard part of the funding landscape but, in reality, they are not. (Except when buying a new house.)
Invariably, the request for a bridge loan is “as soon as possible.” This generally means that, at the outset, this business is not in control of its funding plan. 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. Also, the time pressure to do a deal quickly puts the lender at a tremendous knowledge disadvantage that is hard to overcome in a short amount of time.
From the lender's perspective, if the loan is “successful” and is paid off by a new round of capital, it will generate modest interest income due to the short duration. The lender might get a high internal rate of return (IRR), but not much in real dollars. If it’s unsuccessful, meaning the event being bridged to evaporates, then something went wrong, and the credit risk has increased substantially. Lenders can overcome these economic realities with large fees and warrants, but that makes the costs extremely high for a short duration loan.
In the vast majority of cases, because of the issues above, “bridge financing” is eventually funded by existing investors. Existing investors are not at an information disadvantage and can move quickly. Also, their economics are much different. They might provide the funding at a low cost in order to preserve the value of their existing investment. And finally, if the existing investors are unwilling to fund the business, it’s another bad signal to any new potential lender.
The takeaways here for founders, managers, and early investors are:
- Aggressively work to avoid ever needing a “bridge loan.”
- If bridge financing is needed, do not put a lot of effort or confidence in the ability to fund it externally.
- If it must be funded externally, prepare to pay a lot, AND please don’t call it a “bridge loan.”
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