Venture Debt Uses – Prevent a Bridge Round
Venture capital is designed to take a startup to its next milestone to allow for more equity to come in at higher prices. These higher prices (also known as up-rounds), are often funded by new/outside investors. Due to the competitive process, the market sets the pricing and terms of the deal.
Unfortunately, sometimes these funds don’t last until the next round of funding due to a variety of reasons such as a quarter or two of low revenue, a delay in product development, or a strategic business pivot.
Outside investors may need to see progress before committing to funding. On the other hand, they may be willing to fund earlier but at a steep discount to what they would have paid if the milestone had been met. Current/inside investors are then stuck between taking a lower price from an outside investor or funding the round themselves.
One solution is to extend the prior round, which can be done quickly and may be favorable to inside investors, is if they can buy stock at the old price. However, founders and management may not like this option because they may feel the company is worth more than it was at the last round.
Another solution is a bridge round. A bridge round is a form of borrowing against the next equity raise. This involves insiders investing through a form of convertible note, converting the next round at a discount to that round’s share price and typically comes with warrants and/or an interest coupon. The advantage of a bridge round is it can be done quickly and pushes pricing out until the full equity round.
The disadvantage of a bridge round is it can be expensive. Current investors set the terms and the management team and founders are price takers. Additionally, a bridge round could signal to new investors that the company did not hit its target in the time planned, raising a yellow flag.
A venture debt loan is a favorable alternative to a bridge round because:
- No signalling risk
- Frees up the full amount of equity to be raised fresh at the round instead of prior
- Venture debt does not set valuation, allowing the founders and management team to benefit from a higher valuation they want at a new round