So there’s a lot of angst in VC today. And a lot is about the bridge rounds. What is a round bridge? It’s extra money exclusively from existing investors. And the rounds of bridge are… stressful. Almost always. Nobody really wants to do them. They want a top tier VC to come in and do the next round at 2x, 3x, 10x the price of the last round. Not existing investors who have to go deep into their own pockets.
Now here’s the confusing thing, that the founders don’t understand the way they should. Each larger VC fund carries “reserves”. Extra money used for second checks and third checks. With larger funds, it is often 50% or more of the fund.
But those reserves aren’t unlimited, and they run out. And most are not used for bridge rounds. Most of VC reserves are being used for uprounds, led by new investors. So rounds of bridge are stressful. They come out of a real but limited pool of capital that really only wants to be distributed to winners. Not the ones in trouble.
Still, VCs know that even the best portfolio companies often have a tough time. I too needed a bridge and every Unicorn I invested in had a year from hell. Many needed a bridge, and one didn’t get one and really struggled without it. So VCs know that sometimes you just need to bridge to support yours potential winners.
Ok, so let’s analyze what happens in practice. There are really 3 types of bridge rounds:
“The 0x Bridge”. These are just too common. The biggest sign is when founders end up with just a few weeks of cash and no plans. I have never seen this play any kind of win. When founders hide from running out of money and pressure existing investors to put in more money at the last minute, well, sometimes they get it. But I always see them spending it all and ending up in the same place in a few months. The VCs call it “Bridge to Nowhere”. I did one of these and lost all my money. I won’t make another one.
I made exactly $0 on those investments
— Jason ✨Be Kind✨ Lemkin (@jasonlk) November 18, 2022
“The 1x Bridge”. Now here is where different VCs have different perspectives. There are deals where, realistically, the startup will probably never be hugely successful. The most common sign is that growth has been slow for over a year. A few setbacks, everyone expects it. But once growth consistently slows below 50%, for more than a year…startups pretty much never go back to hypergrowth. Startups are flywheels and engines of momentum. But that doesn’t mean these will fail. A $10 million business growing 20% is still a very real business. Only no one will likely ever be worth $1 billion. So VCs are often faced with a choice here. If a lot of money has already been invested, does it make sense to invest, say, another 20% of the initial investment if this drastically increases the chances that you will at least get your money back? I call these offers “1x Bridge”. The chances of a VC getting their money back, perhaps with a modest return, increase. But that’s all. These bridges also allow VCs to kick the can down the road on a potential cancellation, if the bridge goes long. So these deals are actually quite common if the VCs have the reservations to make them and the founders don’t act too crazy or pushy. The best VCs are fine with losing 1x their money in any single trade. But many VCs don’t want to. If a small second check helps avoid a write-off, it can be worth it, at least in theory, so as a founder, you need to know if you can capitalize on this situation.
“The 10x Bridge”. We saw a lot of that when Covid hit – the shutdown just swamped some top-tier businesses. AirBnb needed it, TripActions needed it, etc. Even category winners need it sometimes. When a true winner somehow gets hit hard. You still know it’s a 10x-100x deal, it just has to get over a hump. These aren’t easy to pass, but… they tend to be completed. And the key here is that the founders are always transparent and clear about why it is, and still will be, a winner. They understand it. These decks are what VCs reserve for. We’ve all done some of these checks in huge results. This also sometimes happens when a high portfolio company goes through a major transition, such as from SMB to Enterprise. Or expand its TAM. Sometimes, there’s just a tough time, but you know it’s a 10x deal. You fill them. This is the job.
So at the end of the day, as a founder, your job is not to run out of money. It really is a top 3 job.
But if you’re running out:
- First, always disclose your Zero Cash Date in every investor update, every month, promptly. This way there are no surprises. That way, your investors are already potentially planning a bridge.
- Second, run to Bad News. Not from it. The best founders aren’t overly dramatic; remain realistically positive. But they are clear if the cash flow will not be enough. And they always have a plan. A real plan, which makes sense. This is not delusional. And they share it soon. When he has 6-8+ months of runway left.
- Third, don’t come up with a delusional plan. Too many non-controlling types build plans that look good but are delusional. What I see most often is making everything come up in the fourth quarter. 5% growth, 5% growth, 5% growth, then 178% growth in the fourth quarter. It looks fantastic! But impossible.
- Fourth, don’t submit a We’ll Spend Our Way Out of a Hole plan. I see this too often in high-burn startups. The answer to a bad time? Spend even more! This way we can raise a big round. It looks good on a spreadsheet. But in practice, the money leaves the fastest and the fastest growth never comes or has any real impact on fundraising.
- Fifth, ask and ask early. Talk quietly to each of your top investors and ask them if they want to invest more money and if they can.
The bottom line is a real plan, maximum transparency and acting early helps increase the odds it won’t be seen as a 0x bridge. Talking about it for real after some good news helps increase the odds that it’s a 10x Bridge. And at least running towards Bad News tends to ensure that it’s seen as a 1x bridge, not 0x.
Read more about bridge rounds here:
How bridge rounds work in venture capital: messy, full of drama, and not without high risk
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Published November 21, 2022