First Step Digital, maker of women’s hygiene and intimate care products, raised an undisclosed amount in a follow-on funding round or bridge funding round, as part of its move towards raising a larger round of $5 million by 2019-end. Mint looks at what bridge funding is.

What is bridge funding?

It is a short-term capital infusion from existing investors in the form of a loan or equity investment. The idea is to help the company tide over its current capital requirements till a longer-term funding option becomes available. In simple words, it is a “bridge" that helps the company in between its investments rounds. Bridge funding is common for startups. However, bridge funding can also come into play during initial public offerings, or IPOs, when they are used to take care of the expenses associated with the public offering and are typically paid off immediately after the listing.

How does it work?

The contours of bridge funding rounds have evolved over the years in response to the financial requirements of startups. As such, the structures tend to vary from deal to deal. It can include debt and equity, and convertible debt. Bridge funding tends to come more easily to firms that are doing well but need short-term loans or capital than to firms that are in distress. It can help a firm reach its next round of funding or undertake strategic initiatives such as acquisitions that can add value later on. It is also often used by firms entering new markets or want to add a relevant line of business to give a boost to their overall business.

Why is it needed?

It is needed for a host of reasons, including situations when a founder is not able to raise a full funding round at a desired valuation or wants to hold on to the equity for a bigger round, but needs immediate access to cash.

What are the elements of bridge funding?

This type of funding could be through short-term, high-interest loans or a debt that converts into equity later. The company may choose to give a small part of the equity to an existing investor as well. If it is an equity-based bridge funding and the startup is already on its way to raise a larger cheque but needs capital for the short term to tide over a few working capital hurdles, the existing investor, who is offering the bridge capital, may insist on a discount of as much as 40% to the valuation that the new investor is coming at.

What are its pros and cons?

When an existing investor puts in more money into a company it often sends a signal of reaffirmation to the market. As bridge funding helps the company tide over short-term financial requirements, it helps the founder focus more on the business. It may also be used for rectifying something or to run a pilot to try a new line of business. However, a founder needs to be mindful and should not liquidate too much or take loans that become hard to pay back because of the high interest rates that are involved.

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