Link to original article: Extensions and bridge rounds are becoming more common. Here’s what you need to know about them.

Extensions and bridge rounds are becoming more common. Here’s what you need to know about them.

Running out of operating capital is a startup’s worst nightmare. Unfortunately, the current rocky macroeconomic climate has shortened the cash runway for many startups.

While in 2021 and 2022, companies could raise another round of capital if they were short on funds, recent data from PitchBook indicates that venture activity for seed and Series A startups has significantly decreased, with deal value now below $10 billion for the first time in 11 quarters. Carta, an equity management solution for startups, reports that total venture capital raised by startups has plunged 80 percent in the past year.

As a result of these conditions, two alternative types of funding — bridge rounds and extensions — are becoming increasingly common as entrepreneurs look for ways to raise extra money.

“The metrics that are required to be a Series A or Series B company are higher than they were 12 to 18 months ago,” says Joe Medved, a partner at venture capital firm Lerer Hippeau, which is actively investing in seed-stage startups out of two funds totaling $230 million. “So you’re just naturally seeing a lot of these kinds of bridge or extension rounds.” Carta data indicates that in Q1 2023, 40 percent of all investments in Series A and B companies were bridge rounds. That is the highest figure since 2020.

In simple terms, an extension is where the most recent round of funding is opened up for insiders to increase their funding, or for new investors to join. Anvil, a San Francisco-based software startup, raised an additional $5 million on top of its initial $5 million Series A round through an extension in Q4 2022. Existing investor Gradient Ventures participated in the extension, in addition to Craft Ventures, another early-stage venture firm.

“Looking at where we were and what we wanted to do, we felt like it would be helpful to have cash on hand, and we fortunately also had investors that were interested in doing that,” says Anvil CEO Mang-Git Ng.

Bridge rounds, on the other hand, are “unpriced financing rounds that occur between primary financings,” according to Carta. They tend to be led by investors from a previous, priced round of funding and are often structured through a convertible note instrument, such as a simple agreement for future equity, or SAFE.

“In a lower-valuation environment, many companies are opting for unpriced bridge rounds instead of a new priced funding that could come with a lower valuation,” Carta noted in the report.

Andrew Headrick, the CEO and founder of Minneapolis-based health care technology startup Kavira Health, raised a bridge round at the end of 2022 in preparation for a pre-seed round later this year. With nearly $1 million in annual revenue, the company raised just under $500,000 from angel investors and family offices to extend its runway.

“We needed money quickly, and VCs were not going to move quickly,” Headrick says. “It was just a quick capital infusion as opposed to trying to come up with a valuation, trying to find a lead investor, and trying to negotiate terms.”

Gaurav Jain, co-founder and managing partner at San Francisco-based venture firm Afore Capital, says that the main difference between an extension and a bridge round centers on the status of the company. “Extension is perhaps a position of strength,” Jain says. “Bridge is ‘I’m running out of money.’”

Anvil had strong metrics going into its extension round, especially in regard to customers and customer retention. “We are a recurring business model,” Ng says. “People still need to file paperwork and documents and get contracts signed to get the services they need.” Ng says that Anvil’s recurring revenue is “north of a million dollars” and that the company has dozens of contracted customers.

Kavira Health was not necessarily approaching its bridge from a position of weakness, however. “I was personally funding and I was running out of capital, so we needed money to keep the business going,” Headrick says. The company, according to Headrick, has been growing about 40 percent month over month for the past 10 months.

Ultimately, macroeconomic conditions forced Kavira Health to pursue a bridge round. “Inflation was running really hot, and investors were starting to pull back,” Headrick says. “It was not feasible for us to raise via institutional investors in the timeframe that we needed to.”

Founders interested in bridge rounds or extensions should start taking action now.

While Afore is a pre-seed fund and rarely invests in bridge rounds, Jain says that investors look for similar things in founders and businesses across financing rounds, including conviction and pace of execution. He says that whatever funding plan founders execute — whether an extension or bridge round — they have to do it early. Thinking ahead enables founders to have more options when it comes to financing. “The key is to be self-aware,” Jain says.

Jain also suggests sending regular updates to investors to “instill trust and confidence.” This enables founders to have conviction when asking for extra capital.

Ng agrees — it is important to maintain relationships with existing investors, he says, as well as those who passed on previous rounds of funding. “It’s better to have these investor relationships in, like, ‘ready to go’ instead of trying to form these relationships in the midst of a crisis,” he says.

Even if your business is not an early-stage startup, it might be a good idea to consider these funding options.

“Even the best of businesses are having to think about this,” Jain says of bridge rounds. “Keep your company alive to fight another day.”