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Bridge Financing Definition
Bridge financing (normally a bridge loan form) is a temporary source of financing to companies and other business units to strengthen their Short-term state up to when a long term funding source works out. In most cases, Bridge financing sources are from Investments banks and venture capital institutions in the form of either debts or ownership contribution such which is capital. Bridge financing in a company with a shorter runaway than its future financing options and there is a need for the company to remain liquid to obtain long-term funds.
Bridge financing fulfills the gap between when an institution funds are planned for depletion to when replenishment is made. The financing in most cases is used to cushion an organization from the temporary risks of fund shortages by providing working capital. For instance, there is a notion in companies that when growth possibilities are likely but short term funds like for five months funding is to be experienced, then Bridge capitalization means can fulfill the would be shortages.
A Little More on Bridge Financing
A bridge loan is one of the possibilities for a company taking temporary and more expensive loans with a high interest rate. Corporations looking for bridge financing through bridge loans need a relative degree of cautiousness although interest rates might be so expensive resulting in more financial troubles. A good example is when the request for a loan amounting to $500,000 which is approved and is to be subdivided with the initial tranche coming after six months. The company might resolve for a bridge loan. With this situation, the company can request for the same period bridge loan to sustain the entity until the first tranche is received in the company’s account
When companies do not want to suffer from the exorbitant interest rates by acquiring these bridge finance, they can resort to venture capital companies for funding until the company can finance itself. In such a case, the entity might sell a percentage like 10 percent of its shareholding interest to a venture company in reciprocating the financial support while anticipating profitable operation during the time the firm would be insolvent.
Investment banking defines bridge financing as a method used by companies before IPO to ensure there is enough fund for IPO activities. On the IPO completion, the funds raised by IPO is used to pay back the loan obligation. Investment bank underwriters provide these funds during the new issue, and there is consideration given by a new company purchasing the bridge finance. Consideration involves giving some shares at a discount, and this forms the basis of future payments for the future sales of new shares.
References for Bridge Financing
Academic Research on Bridge Financing
- Short‐term debt as bridge financing: Evidence from the commercial paper market, Kahl, M., Shivdasani, A., & Wang, Y. (2015). The Journal of Finance, 70(1), 211-255. In this paper, the author ascertained why organizations resort to using temporary, non-intermediated loans by studying markets’ commercial papers. By using the extensive commercial paper database, they established that organization depends on commercial paper as a source of initial capital. The need for minimizing transactional costs associated by raising capital for created investments is the companies’ driving force towards commercial papers. Also, companies with high rollover risks are less probable of entering Commercial paper market and borrow more from banks. Firms frequently refinance long term bonds mitigate rollover risks.
- Bridge financing over troubled waters, Harris, T. J. (2002). The Journal of Private Equity, 59-63. The author outlines the importance of venture capital in raising funds in a company in rounds as needed. Bridge finance is seen as a source of equity financing in subsequent rounds, and it works well as it requires little documentation. Bridge financing has evolved with time from; longer timelines; more complex literature; specific prior terms and conditions; Maturity; security pledge; prohibition on proceeds usage; acquisition followed by conversion; and warranty guarantee.
- Acquisition bridge financing by investment banks, Glazer, A. S. (1989). Business Horizons, 32(5), 49-54. “There are duplet issues that investment bankers must never forget on bridge financing, being a popular source of finance to them”, the writer quotes. The two are the company’s financial risks paused and the extent of possible risks. Investment banks role has changed from mid-1990 when their role in acquisition and mergers could end in transactions finalization. They undertook underwriting and advice to clients. With a time of about 20years, banks have increased their participation in their clients undertaking to include initiating buyout, taking long –term capital and committing them, and availing temporary loans. Investment bankers came up with two methods targeting their clients in raising temporary financial needs. They include: Issuing comfort letter as first used Drexel Burnham and to issue short term commitment letters, Bridge finance.
Debt maturity structure and liquidity risk, Diamond, D. W. (1991). The Quarterly Journal of Economics, 106(3), 709-737. The paper ascertains the debt maturity of borrowers was posseting confidential future credit rating information. Internal sources of cash to borrowers like rent cannot be assigned to lenders and therefore there exist a trade-off structure for optimal maturity in anticipation of the betterment of credit rating compared to liquidity risks. This is the possibility of borrowers losing rents not assigned as a result of the lender’s excess liquidation incentives. There is a preference of temporary borrowing by those with high credit risks compares to low creditworthy possessors’ preferring long–term sources not disregarding the restriction of only short term debts to lower-rated borrowers.
Annualized Returns of Venture-Backed Public Companies Categorized by Stage of Financing: An Empirical Investigation of IPOs in the Last Three Decades, Shachmurove, Y. (2001). The Journal of Entrepreneurial Finance, 6(1), 44-58. The author highlights the proliferation of misconceptions in venture capital even though a lot of concern has been given by international media. The paper tries to prove the myth of high rates demanded by investors to counters the high risks in venture capitalization. About 3,063 companies supported by venture capital between 1968 and 1998 have been under investigation by this paper to determine their performance during their Initial Public Offer. Companies were grouped as either actively trading or not during the funding. The significant finding was that there is a variation of annualized returns between active and inactive traded firms during financing stages but are relatively lower than those reported by media and venture capital.
Angels: personal investors in the venture capital market, Freear, J., Sohl, J. E., & Wetzel Jr, W. E. (1995). Entrepreneurship & Regional Development, 7(1), 85-94. Examination of private investors’ role of new technology-based ventures in equity financing was carried out by the author. The study concentrated on venture capital markets from an economic point of view of demand and supply. Besides, the perception of entrepreneurs in venture capital was also included in the investigation. Examination concentrated on private investors as preferred financing sources for finances valued at less than $500,000. There is a value addition for both venture capital and private investors fund by providing their respective ventures with working relationships which are seen as productive components by entrepreneurs.
A model of the Canadian housing and mortgage markets, Smith, L. B. (1969). Journal of Political Economy, 77(5), 795-816. The author talks of the many studies that have been undertaken regarding the mortgage market and residential construction sector. The studies main task has been examining the specific market’s aspects such as the relationship between the availability of loans and residential construction cycles, the financial institution lending nature, and the magnitude of stock variation of housing demand concerning income and price. The paper was intended to use different studies in coming up with the housing mortgage model with emphasis placed on the financial variables’ roles.
External revolving loan funds: Expanding interim financing for land conservation, McBryde, M., Stein, P. R., & Clark, S. (2005). From Walden to Wall Street J. Levitt (ed.), 73-89. The paper emphasizes on the borrowing necessity when a firm has to close on real estate transactions before securing all the funds. Several conservation-based organisations which are nonprofit manage revolving fund providing either low or no interest short term loans to facilitate land easement purchase for conservation activities.
Patents, venture capital, and software start-ups, Mann, R. J., & Sager, T. W. (2007). Research Policy, 36(2), 193-208. The paper carries the analysis of the relationship between the firms’ processes during the venture capital cycle and the patenting behavior these firms during their start-up time. There is a meaningful and positive correlation between the variables measuring firms’ performance and patenting upon data linkage patent and capital financing of new software firms. Finding were: Ratio of venture-backed software companies to similar companies patented was about one to four, there was considerable variation in patenting practices in the software industry, and there was less dependability on the between the patent metrics of firms performance and patent portfolio than the firm possessing a patent and more.
Venture capital financing: A conceptual framework, Lam, S. S. (1991). Journal of Business Finance & Accounting, 18(2), 137-149. In this study, the Bayesian approach explaining the imperfect information of investors about the parameters of the company’s underlying return generation process results to estimation risk is described by the authors. Lenders are not willing to issue large loans because of less or absence of security coupled with high estimation risks.
Recent developments in financing-related provisions in leveraged buyouts, Sorkin, D. J., & Swedenburg, E. M. (2006). Recent developments in financing-related provisions in leveraged buyouts. The writer examines Leverage buyout (LBO) which is privatization of companies by buying the shares and allocating narrowed ownership composed of managers, general partners, and other limited partners, developments in Europe and the possible monetary implications. The observed mergers and acquisition in the past were contributed by a surge in private equity transactions more specifically leverage buyout.