Bridge Loans

By John L. West

It must be the temper of the times: Low tide for the public securities markets--no IPOs, no liquidity. Low tide for valuations--this goes along with lack of liquidity. Low tide for equity fundraising.

The entrepreneur who has actually tried to raise equity since late 2000 has learned one thing. The articles and speeches about how tough it is to raise funding for ventures are exaggerated. It is tougher than they say.

Enter the dreaded bridge loan. The term "bridge loan" has been around for years. Now those who had only passing acquaintance are fast becoming familiar with it. In one sense all loans are bridge loans. You borrow money for awhile and then repay it. The loan bridges you from now, when you need cash, to then, when you have it to pay back.

In the context of an entrepreneur growing a business, a bridge loan can be a lot more complicated and a lot more painful. The catch is in the added terms. A bridge loan is high risk for the lender which therefore requires a high return.

So what can an entrepreneur expect?

1. A basic note with a maturity date and interest, maybe a high rate of interest.
2. An equity kicker to the lender, usually in the form of warrants.
3. Perhaps a security interest in property to secure the loan, if there is any unpledged property available.
4. Convertibility into equity for the loan if milestones are met, such as new equity raised or revenue targets reached, etc.
5. Accelerated payback of the loan (or a multiple of the loan) if certain "liquidity events" occur, such as the sale of the business.
6. Restrictions on management payments, other debts and distributions--such as those one often sees in bank loan agreements--both affirmative and negative covenants.
7. Preemptive rights in favor of the lender to participate in future equity offerings.
8. Renegotiation of prior agreements, such as antidilution provisions, if the lender was already an investor. A give-back of some founder's equity might also be involved.
9. Transactional costs. All the complexity of today's bridge loan takes time and costs money to document.

Just how high the interest and how many the warrants and how tight the management controls vary wildly depending on the relative bargaining strength of the parties, and how the investor evaluates the risk and possible rewards. Bridge loans are not likely to be considered "friendly" to the entrepreneur. Especially when compared with the terms of your last equity financing pre-mid-2000, the lenders requests may be considered aggressive.

Bear in mind that when it comes to getting more financing, time is not on your side. The closer a company is to the edge of the cliff, the greater the leverage in favor of the lender.

What it comes down to in the end is whether the company is better off with the bridge than it would be without it. In that sense, the availability of the money may be worth the extra pain. A bridge may carry a high toll, and it may lead to a win-win on the other side.

What's an entrepreneur to do? Seek advisors whose experience can help evaluate alternatives, weigh the demands of the lender, maintain flexibility so the business can operate efficiently, assist documentation and preserve value for all shareholders.