Bridge Capital - What Is It & When Do You Need It?

Companies use bridge capital as temporary funding, to cover short-term needs like closing an acquisition or covering the pre-IPO operating period, while they wait for permanent capital transactions to close.  For example, if you are looking to buy a local competitor and the bank term loan might be held up for months, you may decide to turn to high net worth individuals or other bridge funding sources to close the deal sooner and get into business.   While most bridge fundings contemplate the closing of a transaction, it can also be used to cover working capital needs such as the period before a new contract with a major customer is about to fund.

There are a number of variables with bridge capital that you should consider:  cost, speed of financing and required collateral being three primary ones

Risk Equals Cost

Bridge capital can be fairly expensive capital because of the nature of its use.  You are asking a capital source to provide a sizeable funding in a relatively short period of time, usually to cover capital needs before a transaction of some sort.  The bridge firm has little time to perform due diligence and when it does, it is not only looking at your business, it is looking at the other principals or business involved in the transaction you are trying to close.  Accordingly, the bridge firm can have significant risk, especially because the liquidation of its investment is generally dependent on a transaction closing.  Look for the cost of the bridge capital to be priced at its perception of the risks involved.

The type of securities usually purchased by bridge capital sources include short-term, high yield secured notes with equity options and/or conversion features.  An example of a bridge capital instrument might be a 90 day secured note bearing interest at prime+5% with an option to purchase 1% - 4% of the business.  Security provisions might include the personal guarantees of the principals.  Obviously if your company already has secured debt, such as bank financing, in place, the bridge capital provisions will have to reflect those capital agreements.  If the bridge firm is unable to obtain the collateral they want in their security provisions, they will increase the other pricing components - interest and equity.  It may seem outrageous when you first view the term sheet, but remember, like any other business, they are looking for a suitable return on investment (ROI).  And bridge capital firms price their capital for the downside - if there is a way to secure their investment, they will.  TIP:  Because the amount of time a bridge financing is outstanding is a key determinant of its cost, try to negotiate a reduction of that cost for retiring the investment ahead of schedule.

Our Recommendation

As a general rule, we are wary of bridge capital transactions, while recognizing their potential benefits.  If you are contemplating a bridge financing, be very clear on why you are not waiting for your permanent capital to close.  Unless there are pressing business concerns, you should probably take the extra time to let the transaction go through with permanent capital sources.  In addition, use institutional debt sources like banks, finance companies, leasing concerns and SBIC's whenever you are seeking debt capital - even for short-term, temporary needs.  Work with a local bank to obtain a working capital line of credit to be used the same way you might use an equity line of credit on your home.

Time shouldn't have to cost this much to a business, but it does.  Your job is to make sure that it is worth the cost.