📈How Investing in Bridge Rounds Landed Us Multiple 10x+ Returns

📈How Investing in Bridge Rounds Landed Us Multiple 10x+ Returns

Before we jump into today’s post, I want to shout out my Last Money In partner/co-author Alex Pattis, who was recognized by Business Insider as one of the 68 most important VCs in New York. Congrats to Alex on the much deserved recognition!

Now on to this weeks post…

📈How Investing in Bridge Rounds Landed Us Multiple 10x+ Returns

First let’s define a bridge round. A bridge round is a type of funding that is used to extend the runway of a startup until it can raise the next round of venture capital funding. It is usually a smaller amount of money than a normal priced round, and it is often structured as a convertible note or a SAFE (Simple Agreement for Future Equity).

While in the best case, a venture capital investor or syndicate would have invested in a top performing business at the earliest stages – referred to as angel rounds or Pre-Seed/Seed financings – a next best way to invest in a high performing business is through bridge financings. Why is that?

We believe two main reasons – bridge rounds can present “value” (more on that below) and/or bridge rounds can be a way to invest in business that is otherwise inaccessible as future larger priced financings may be taken completely by 1-2 large investors + pro-rata investors, leaving no room for other new VCs.

As defined above, bridge financings are essentially in-between financings, and do not fall into the typically defined financings of Seed, Series A, Series B etc. but rather are done in between these rounds and are usually smaller in nature. The goals of a bridge are extremely different based on the needs of the companies, but ultimately fall upon some milestone. These goals can include

• Extending runway to reach product market fit

• Extending runway to reach a satisfactory financial target (ARR, Revenue, etc.) or other target

• Extending runway based on a pivot (exploring new product, business model, etc.) in the business

• Adding capital to hire necessary personnel to better capture an existing/new business opportunity

In most cases, the Company doesn’t feel it has reached the necessary goal or state of the business to justify raising a large financing and so rather than going out to market for a large raise (and likely a less than optimal valuation), a company will raise a small bridge to hit its milestones (as referenced above).

Like any investment, not all bridge rounds are good investments – many in fact, are bad investments. We frequently see bridge financings for companies that have no line of sight to product fit or reaching their financial targets and are rather “bridges to death.” Meaning the bridge is a last ditch effort for the company to more or less just survive. These investments can work out but are generally significantly riskier.

So why do we like bridge rounds if by its very nature it means the company may not have hit its goals to be able to raise a large, priced financing?

One reason is simple accessibility to the best companies whereas there may not be an opportunity; another reason is it allows insiders to double down on winners ahead of larger more expensive financings. But the bigger reason is “value.” Value is a term rarely used in venture capital, but bridge rounds can present value and a lot in certain cases.

Why is that?

Because the dollar amount raised in bridge rounds is typically small in nature, a company is often willing to sacrifice optimizing valuation for speed to raise given the amount raised is likely a small dilution hit for the company – a 5-10% dilution hit as opposed to the 25-33% seen for many priced financings.

To preserve confidentiality, we won’t be disclosing the actual names of the companies below, but here are a few of the bridge rounds we invested in over the last few years.

• Company A (industry: autonomous) – Seed Bridge Round →10x return distributed ~1 year later

• Company B (industry: SaaS) – Series A Bridge → ~16x markup within ~2.5 years in a round most recently led by Insight Partners

• Company C (industry: VR) – COVID bridge → raised at valuation cap at ~10x higher in ~2 years; raising priced round we believe will be at or higher than the cap right now

• Company D (industry: Fintech) – Series A ext. → ~10x val, markup in less than 2 years, unicorn priced by Goldman Sachs

• Company E (industry: CPG) – COVID/Seed Bridge Round → ~41x val. markup in less than 3 years in a series C round (not yet announced)

And the list goes on….and all of these companies we syndicated to our LP base via SPVs that any accredited investor who joined our syndicate could have accessed. Notably, 2 of the 3 aforementioned companies that haven’t distributed have an opportunity to 5-10x+ from here, meaning these bridges may result in a 100x or a fund returner (assume investment size equal) for most funds.

The key when evaluating bridge rounds as an LP or GP in an SPV is being able to discern is this a bridge for a high performer or is this a bridge to nowhere. So how can an LP in an SPV discern this with limited information:

1. KPIs – as a starter, is this business growing quickly; is revenue growing 2-3x+ YoY, while operating efficiently – if yes, it may be a high performing business

2. Co-Investor List – is a large part of the bridge being taken by an insider or by a new highly notable investor – if yes, this may be a positive signal

3. Progress – since the last round has the company made satisfactory progress in other ways e.g. has it reached technical milestones if it’s a deep tech business; has it added best in class talent to its leadership team; has it found a new business opportunity that is working as validated by KPIs, contracts, etc.

If it hasn’t checked these boxes then it may be a bridge to skip out on. Not always though – famously Slack pivoted away from being a gaming company to a cloud based communications company used by tens of millions of business professionals today. It’s unknown to me if they ever had to raise a bridge to execute on its pivot, but nonetheless, the business took a massive pivot early on and it worked out for investors as evident by its $28B exit to Salesforce.

Okay so at this stage, you may have some good sense if the bridge is for a compelling business and that the bridge financing will ultimately be a clear accelerant. If that’s the case – then the next step to figure out is their value here – in other words are investors in this bridge coming in at a discount to fair value or more in line with the actual value of the business. If it’s the latter, you may still want to invest as investing at fair value in a high performing business can generate expectational returns, but hopefully by nature of being a bridge, investors are getting some value in the opportunity.

So how do you determine if there is value in a bridge?

1. Is the round being priced at or near the last rounds financing – if the business has grown substantially, but is being priced at the last round’s pricing (all else equal), then there may be value in this raise

2. Is the multiple being put on the business below its market comparables – if so, there may be value in this raise

3. Does the SAFE or Note come with a satisfactory discount (20%-30%+) to a near term financing – if so, there may be value in this raise

4. Is the lead GP running the SPV investing an outsized amount in the company – if so, there may be value in this raise

As you can see, value can come in a lot of ways – many more than I laid out – but ultimately, there should be clear signs in the deck, terms/investors and memo provided by a GP that enable you to sift through this information to evaluate whether you have the unique opportunity in venture to invest in a high performing business at a discount to fair value.

Let me conclude by restating that not all bridges are good and generally the variance between “good investment” and “bad investment” is substantially higher in bridge rounds versus priced rounds. But hopefully some of the info can provide a framework to help LPs determine this.

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We’ll be back in your inbox next Wednesday on our next topic. Thanks for tuning in!

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✍️ Written by Zachary and Alex