How do venture capital firms evaluate companies in the bridge stage?

When Airbnb was rejected by venture capitalists, the startup raised $30,000 by selling cereal boxes. These funds allowed the startup to survive until its eventual seed funding round. While not all startups turn to cereal boxes to keep their vision alive, it is not uncommon for some to rely on bridge funding to survive until the next funding round.

However, bridge funding comes with heightened scrutiny from investors. In this article, we will explore how venture capital firms evaluate companies in the bridge stage. Read on to know more!

Why do startups go for bridge funding instead of full-fledged funding?

When a startup needs additional and immediate cash, it may seek bridge funding, typically from its existing investors. In such situations, setting up a full-fledged funding round can be time-consuming, resource-intensive, and distract the management from mission-critical tasks.

To close a full-fledged funding round, founders must prepare detailed financial models and pitch decks, identify investors, make cold calls, pitch the investment opportunity, facilitate due diligence, and negotiate term sheets. This process alone can take several weeks to several months and even after closing funding rounds, it may take a few weeks to get the money from the investors.

In contrast, existing investors can afford to spend less time on due diligence and there already is a certain degree of consensus regarding the startup’s valuation. Hence, bridge funding rounds may provide swifter access to funds.

Some of the reasons why startups may go for bridge funding are:

• Covering cash flow gaps – Difficulties in generating revenue may push a startup to the point where it can either continue operating and eventually run out of money or close shop to avoid further losses. Getting out of such predicaments may require significant marketing expenses or strategic product pivots.
• Scaling operations – Changes in market conditions or technological advancements may present unexpected opportunities, capitalizing on which may require investments.
• Achieving key milestones – To ensure larger valuations in subsequent rounds, startups may seek additional funds to achieve goals set in previous rounds.
• Navigating crises – Economic recessions and business cycles can adversely impact even the most promising businesses.

How do investors evaluate startups seeking bridge funding?

In a bridge funding round, investors may evaluate based on the following angles.

Efficient utilization of funding

Needless to say, investors may not want to provide additional funds to a startup that has misused the funding it has received so far. A major red flag that drives investors away is extensive marketing expenditure without any significant achievements on the product development front. Well-managed marketing campaigns can accelerate revenue generation, however, marketing an incomplete product will just lead to a loss of trust among early adopters which can further slow down revenue generation.

Also, if a startup’s founders are over-compensating themselves while the company struggles to gain traction, it will draw the ire of investors. A prime example of this would be the $445 million exit package that Adam Neumann received in 2019 as WeWork was heading toward bankruptcy. This payout significantly depleted the company’s reserves and damaged its reputation. In January 2019, WeWork was a high-flying unicorn valued at $47 billion. However, by November 2023, the company had to file for bankruptcy as its market capitalization dropped to $44.5 million.

Progress towards goals

In a bridge funding round, investors are trying to ascertain whether the additional funds would enable the startup to reach the next full-fledged funding round or if it is time to conclude the journey. To gain investor confidence in such a situation, the founders must validate the startup’s ability to overcome current challenges by highlighting the progress made so far.

While progress on other objectives is valuable, the primary focus will be on the goals established in previous funding rounds. Nevertheless, some encouraging signs can be improvements in customer acquisition costs (CAC), monthly recurring revenue (MRR), and burn rate.

In addition to these quantitative factors, investors may also look at qualitative factors such as strategic partnerships, quality of leadership, and a clear alignment between market needs and product development roadmap.

A prime example of qualitative factors saving a startup occurred when NVIDIA secured a $5 million investment from SEGA, despite failing to deliver a graphics unit for SEGA’s Dreamcast in 1996. At that time, SEGA President Shoichiro Irimajiri invested purely based on his belief in Jensen Huang, NVIDIA’s CEO, and his conviction in the company’s potential for success.

Viability of proposed plans

In your bridge funding pitch, after you have laid the foundation by validating the startup’s progress, you must begin by transparently addressing your current challenges. You can be excused for being unable to respond to unpredictable shifts in market conditions or technological advancements but you must be able to identify any internal sources contributing to your challenges.

It is important to show that you are already tackling these internal issues, rather than giving the impression that you are trying to solve the problem through money alone.

Without thinking too much on the problem identification aspect, you must present a detailed plan to move your startup towards the next stage. This plan should contain any internal changes you plan to make, your product development roadmap, planned expenditures, talent requirements, and a clear timeline for achieving key milestones. You must elaborate on how the bridge funding will directly contribute to reaching the next stage.

If you plan to redefine your goals, you must clearly state why you are doing so. It is not uncommon for startups to make strategic pivots. 37signals used to be a web design consultancy before it developed various productivity management tools like Basecamp. However, investors must see a clear benefit from such a pivot. The benefit could be capturing an untouched market, gaining significant cost efficiencies, improving customer retention, or enhancing scalability, but it cannot be indistinct.

Venture debt – Alternative bridge funding

Since traditional banks and financial institutions have an affinity for low-risk borrowers such as established corporations, founders often overlook venture debt as a form of bridge financing. Venture debt can be an effective way to extend your startup’s runway without incurring additional dilution. Typically, lenders will extend venture debt in the range of 25% to 40% of the previous funding round.

This is a type of debt that is extended to venture-backed startups and usually has a tenure of three to five years which includes an interest-only period of three to twelve months. As a result, it places much less strain on your cash flow compared to traditional debt.

Eqvista – Turning Ideas Into Impactful Ventures!

When the funds raised in previous funding rounds fall short of propelling a startup to the next level, it must raise funds from existing investors in a bridge funding round. In such situations, bridge funding rounds are preferred since a full-fledged funding round can last for a long time and divert attention from critical tasks.

In a bridge funding round, investors evaluate on three fronts. Firstly, it is crucial to ensure that the startup has utilized its funds responsibly, avoiding waste on ineffective marketing campaigns or excessive management compensation. Second, they evaluate the progress made toward the objectives set during previous funding rounds. Lastly, founders must present a clear and viable strategy for achieving the next stage of growth. In addition to equity funding, venture-backed startups can also approach lenders for venture debt if the funding is urgently required and there is a need to manage dilution.

At Eqvista, we have partnered with Cheqly to assist startups in gaining access to venture debt. Contact us to know more!