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Understanding Bridge Financing

written by: •edited by: Jean Scheid•updated: 5/21/2011

Bridge financing while risky, provides a company with much needed cash for expanding their operations. Lenders who offer investments using mezzanine debt financing have a higher likelihood of making money on their investment because they take senior priority compared to other investors.

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    Differentiating Seed Capital From Bridge Capital

    Mezzanine Capital Companies who are just getting started are typically in need of financing to get them started. In many cases, they will turn to venture capital financing as a method of obtaining the funds necessary to launch their business. While venture capital (also called seed capital) has its pros and its cons, this is still one of the most common method of securing financing for a start-up company that anticipates very high sales, especially high-tech companies. Once a company has developed a track record, they no longer have to be as concerned about capital as they have developed a stronger balance sheet and they are able to borrow money.

    Companies that launch and anticipate making a public stock offering sometimes need additional capital for expanding. Expansion may involve launching new product lines, hiring new employees or investing in additional facilities. Generally, these companies have established themselves too well to request additional venture capital funding and may not want to add additional debt to their balance sheet. When a company is preparing to go public, adding new debt reduces the price of the stock. This is when it is highly likely that a company will turn to mezzanine financing. Typically, this type of funding is considered an additional stage of financing, known as the third stage.

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    Understanding the Benefits of High Risk Financing

    Growth expectations There are some reasons mezzanine financing is more attractive than bank loans, personal loans or other forms of debt a company may use to expand their operations. Benefits for the investor include:

    High rate of return - For most mezzanine debt, the investor will realize a high rate of return. Many venture capital companies use these returns to help them fund large-sized new start-ups with potential of high returns, because this type of capital is highly marketable.

    Company position - When an investor makes a debt investment using mezzanine funding, they are able to negotiate for an equity position in the company. Since most companies who are seeking this type of financing, are considering going public with an Initial Public Offering, the time the debt is outstanding is generally very brief.

    There are benefits to companies who use this type of funding as well. These include:

    Less paperwork - One of the fascinating features of bridge financing is that there is typically very little vetting of the company. In most cases, the investor in this type of expansion will be the same investor who provided the company with their original venture capital. This means a faster turn-around time on the funding and avoids a lot of scrutiny.

    Payments are usually non-existent - Unlike other forms of borrowing, this form of bridge financing is generally repaid to the investors out of funds raised from offering stock to the public. This means there is no negative entry on the company balance sheet since in reality, this debt is covered with an equity position in the company. The net result is higher assets, not higher debts.

    Companies who are interested in expanding may elect to explore mezzanine debt finance as once funding resource. Before agreeing to any terms and conditions, it is a good idea to consult with a legal and financial expert.

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