Start-ups cross the 'bridge' for funds

Bridge rounds provide new lease of life to start-ups, come at 15-20% discount to Series-A valuation

A Mumbai-based start-up had raised $500,000 in seed funding from early-stage venture capital (VC) firms. It has shown good traction, but it is far from meeting the milestones in a year to raise a Series-A round. The reality is that it takes time to build a business in India.
 
The investors have two options: To let this start-up die or give it some capital and hope it achieves the metrics needed to raise the next round of funding. This is what investors call a bridge round, which provides a start-up with a new lease of life and extends its runway.
 
The reality for an early-stage investor, says Karthik Reddy, managing partner at Blume Ventures, is that late-stage investors want lot more validation: ‘‘If you have raised $200,000-$500,000 for 12 months, it is not enough to build a very large business that a Series-A investor wants to see. Which means you have to build a little more runway.”
 
‘‘Sometimes $200,000-$500,000 is not enough to show the validation needed to show traction, that you are ahead of the pack. It’s inevitable that a start-up would come back and say, we have run out of cash, and you need to budget in for a bridge round,” he says.
 
The bridge rounds, which were few till three years ago, are gaining ground: There were 16 firms that raised $1-2 million each in 2016.
 

Bridge to nowhere
 
There are various types of bridges: Distress bridges or good bridges, and bridge to nowhere. Sometimes, a bridge-round can help a start-up pull off an acquisition or get acqui-hired, and find a home for themselves. Here, investors are betting that they can recoup some of the value, and advance enough money to keep it alive for another three months. “It’s both an emotional decision and hopeful decision,” says a VC.
 
In some other cases, it’s a bridge to nowhere. A Mumbai-based VC firm, which extended Rs 25-60 lakh in bridge rounds to different start-ups in its first round, lost money in half of them. In the other half, a few distress bridges led to favourable outcomes, where it managed to recoup the bridge money, but not the original investment.
 
In one particular case, where it extended a Rs 50 lakh bridge, the start-up could not break-out, but its product was acquired by a firm and the VC was able to recoup the bridge, but not the Rs 75 lakh-original investment. 
 
Positive outcomes
 
Do these bridges lead to an outcome where the companies survive, improve their metrics and break even? Unlikely as the categories are dicey. Yet, VCs do bridges as they are hopeful of reclaiming some value. For instance, in a particular case, a VC firm extended a Rs 25 lakh bridge over a Rs 1 crore investment in a start-up after it found a buyer for the asset, and recovered its principal as well as the bridge.
 
‘‘Sometimes, a Rs 25-lakh bridge can deliver a 5-bagger in a three-month period. Investors do bridges when they continue to believe in the product, the founder,” says a VC. Two of Blume Ventures firms that received bridge rounds, were bought by Freshdesk; the VC was able to recover its investments of Rs 7-8 crore.
 

Budgeting for bridges
 
Investors have started budgeting for bridge rounds in newer funds. ‘‘If we had invested $300,000 in a firm, we are willing to invest $500,000 more if the business is doing well,'” says a partner with a VC firm.
 
Often, one can find external investors who are looking at interesting entry points — they are willing to come in at a pre-Series-A price and not Series-A valuation. Bridge rounds are typically done at 15-20 per cent discount to the Series-A valuation, which is left open. While that is an ideal situation, in reality most investors investing $500,000 for an 8-10 per cent stake in a company want to freeze the valuation.
 
‘‘It was impossible to do a bridge-round four years ago. But today, there are lot of cheque writers in the $250,000 — $500,000 range,'' says Reddy of Blume Ventures. These include small VC firms, family offices, and foreign investors like Beenext, M&S Partners, Simile, and Dream Incubator.
 
Another driver for bridge rounds is that there are far more start-up at the top of the funnel with no major addition in the number of players doing Series A/B/C funding. Even though larger VC firms like Sequoia Capital, Accel have raised large funds, they have large existing portfolios to support and are looking to invest in less risky assets.