Questions from the Arena: Should I Do a Bridge Round or a Down Round?
This question came to us recently from a CEO in the arena. We are sharing our response publicly for the benefit of other CEOs. All identifiable information has been changed.
In a recent post by my colleague Jonathan Niednagel, he discussed how CEOs are faced with many “lose-lose” decisions in their role as CEO. I was advising one CEO (Sarah) on such a situation over breakfast a few weeks ago.
Sarah was struggling with what felt like to her a “lose-lose” decision. She was deciding between a $3mm bridge round led by existing investors that didn’t provide the full runway she wanted to execute on her next phase of growth or a $6mm Series B down round led by a new investor that provided sufficient capital but at a valuation about 25% lower than her last round. As her omelet was being served, Sarah asked, “Should I do the bridge round or the down round?”
Having any options in a down market is better than no options at all.
First, I needed to understand why when she mentioned the words “down round” it sounded like she was describing a death sentence. Of course, nobody wants a down round as it is economically painful for non-participating shareholders and administratively burdensome (i.e., triggering anti-dilution protections, repricing of employee options, etc.). When Sarah mentioned that she was worried about bad optics, I explained that not all down rounds are created equally.
A down round due to macro-economic conditions does not have the stigma of a down round caused by poor company execution. As investor Brad Feld at the Foundry Group wrote last year, sometimes down rounds are simply the recognition of our new economic reality, which certainly was the case here as her company’s Series A financing in 2021 had multiple, competing term sheets and she chose the lowest valuation at that time. Optics were not a real issue.
I then asked about runway duration.
“Where do you end up after the bridge vs. the Series B?” I asked. After the bridge round, Sarah would probably have only about two quarters to demonstrate traction for a new product line she was in the process of building and launching. Not necessarily a “bridge to nowhere” but not ideal. The additional capital in the Series B would provide multiple additional quarters to prove customer adoption post-launch, which was important as Sarah was selling into the slow-moving enterprise market.
Finally, I asked about the certainty of each path.
“How far along are you with the outside investor? How committed are the inside investors to the bridge?”, I probed. The Board had met recently and verbally committed the funds to the bridge at a flat valuation to the last round. The Series B lead, however, was 4-months into diligence and still asking for “just one more thing.” That was disconcerting, particularly since economic conditions were providing headwinds on business performance. In addition, the champion of the deal was not a partner at the firm but a VP and he may not have had the political muscle to get the deal over the finish line.
Confronted between two conflicting maxims – take the money when offered (Series B) or take the bird in the hand (bridge), my advice was simple – pursue both!
After some great discussion, Sarah and I agreed that she should press her lead to get her a term sheet in the next few weeks with the fact she had an alternative option in hand (which she did in the form of a bridge). This would give her the best chance of closing the Series B before year-end. After 30 days, if they didn’t deliver the term sheet, Sarah could turn to the bridge note which should still be available as all investors appreciate the effort to source an external lead vs. simply relying on the money around the table. But either get a term sheet in by the end of the month or close the bridge round; don’t let either option linger too long.
I ended my breakfast with Sarah reminding her that this wasn’t a lose-lose situation at all. She had multiple viable financing paths to execute a solid growth plan under either scenario. While it may feel negative relative to the bull market when she raised her Series A, having options in a down market is better than no options at all.
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