The bridge round that cost more than the money

The appeal of a bridge round is not really the money. It is the speed. A priced equity round means agreeing a valuation, and agreeing a valuation means weeks of argument with people who hold most of the cards while your runway shortens by a week each week. A convertible instrument skips all of that. You take the money now and let the next round decide what it was worth.

That is a genuinely useful thing to be able to do. It is also where founders sign terms whose cost they will not see for a year. The illustration below is composite rather than one company's file, but the mechanics and the maths are exactly how these deals work out.

The deal that looked cheap

A company with 1,000,000 shares in issue is four months from running out of money and about six months from the metrics that would support a decent round. An existing investor offers £150,000 as a convertible loan note: 8% interest accruing, converting at the next qualifying round at a 20% discount to the round price, with a £4 million pre-money valuation cap.

It reads as a modest deal. Twenty per cent feels like a reasonable premium for taking early risk, and the cap sounds like a technicality. Nine days later the money is in the account. Eleven months later the round closes at £6 million pre-money with £1 million of new investment, and the conversion is calculated.

What the discount and the cap actually did

At £6 million pre-money over 1,000,000 shares, the new round price is £6.00 a share.

The 20% discount would convert the bridge at £4.80 a share. The £4 million cap converts it at £4.00 a share. The investor gets whichever is better for them, which is the cap.

The accrued interest converts too — that is the default in most notes. Eleven months at 8% on £150,000 adds £11,000, so £161,000 converts at £4.00, issuing 40,250 shares. The new money issues 166,667 shares at £6.00. Post-round there are 1,206,917 shares.

The bridge investor ends up with 3.33% of the company for £150,000. Had they simply written the same cheque at the round price, they would have taken 2.10%. The extra 1.23 percentage points is the price of those nine days.

Look at it from the other end and it is starker still. The cap meant the bridge money bought in at an effective £4 million valuation when the company was demonstrably worth £6 million — a 33% discount, not the 20% on the term sheet. Nobody misled anyone. The founders simply did not run the numbers against a valuation that turned out well.

A cap is not a safety net for the investor. It is a second, better discount that appears exactly when your round goes well — which is the scenario you were working towards all along.

The tax relief that quietly disappeared

This is the part that hurts more than the dilution, because it is avoidable.

A convertible loan note is debt. The investor has lent money and it earns interest. Shares issued on conversion of a loan are not paid up in cash in the way SEIS and EIS require, so a convertible loan note does not qualify for either scheme. For an investor who assumed 50% SEIS relief or 30% EIS relief was coming, that is a serious change to their return, discovered late.

The alternative, where the timetable allows it, is an advance subscription agreement. The investor pays now for shares to be issued at the next round. Because it is not a loan, it can sit within SEIS or EIS — but only if it is drafted correctly. HMRC expects the shares, when issued, to be ordinary shares, and expects the longstop date to be no more than six months from the date of the agreement. Longer than that and advance assurance becomes unlikely. The money must also be non-refundable and cannot carry interest: the moment there is a right to get it back, or a return on it, it looks like a loan again.

That six-month window is the real constraint. An ASA is a poor fit for a bridge that might need eleven months. A convertible note handles the timetable but shuts the tax relief down. Choosing between them is a real trade-off, and it should be a decision rather than something the first draft decides for you.

For the wider picture on the schemes themselves, EIS and SEIS explained for founders raising money sets out the limits and the reliefs.

The clauses that decide how bad it gets

Four terms do most of the damage, and all four are negotiable.

Interest, and whether it converts. On a bridge, interest that rolls into the conversion is not a yield — it is additional dilution that grows the longer you take. In the example it added 2,750 shares. Ask for a lower coupon, or for interest to be repayable in cash rather than converting.

The cap, and whether there is one. If the discount and the cap both apply on a best-of basis, you have given away two things and been told about one. Model the conversion at three plausible next-round valuations before you sign. It takes twenty minutes and it is the single most valuable thing you can do with the term sheet.

The longstop. What happens if the next round never comes? Standard notes either convert at a specified default valuation or become repayable. Repayable is a fiction for a company that failed to raise — the cash will not be there — so a maturity date with a repayment trigger is really a clause that hands the investor leverage at your worst moment. Automatic conversion at an agreed default valuation is the founder-friendly version.

Most-favoured-nation and consent rights. A short note can carry a right to match any better terms given later, and a veto over the next round's structure. Read what you are signing over, not just the number.

What we would do differently

Model the conversion before you take the money, not after. Three scenarios, twenty minutes, on the back of an envelope if necessary: what does this investor own if the next round prices at £4m, at £6m, at £10m? If the answer at £10m makes you wince, the cap is doing more work than you realised.

Decide the tax question deliberately. If the investor is a UK individual expecting SEIS or EIS relief, an ASA with a six-month longstop is a different conversation from a note — and it is a conversation to have before the drafting, not after.

Raise enough to actually clear the obstacle. A bridge sized to reach the round only if nothing goes wrong is the most expensive kind, because the second bridge is priced by someone who now knows you had to come back.

And be honest about what the speed is worth. Nine days instead of eleven weeks was, in this case, worth 1.23 percentage points of the company. Sometimes that is a bargain. It is only a bad decision if you never worked out the price. If you are earlier in the process, what investors actually look for before they write a cheque and raising money before you agree what the company is worth are the two to read first.

Common questions

Can a convertible loan note qualify for SEIS or EIS?

No. A convertible loan note is debt: the investor lends money, it typically earns interest, and the shares issued on conversion are not subscribed for wholly in cash in the way the schemes require. That makes the investment ineligible for both SEIS and EIS relief. Where investors need the relief, the usual alternative is an advance subscription agreement, which can qualify provided the shares issued are ordinary shares, the money is non-refundable, no interest is payable, and the longstop date is no more than six months from the date of the agreement. HMRC is unlikely to give advance assurance on a longer longstop, so the six-month limit shapes the whole structure.

What happens if the next funding round never happens?

That is what the longstop date governs, and it is the clause worth negotiating hardest. Convertible notes typically either convert automatically at a specified default valuation on the maturity date, or become repayable in cash. Repayment is largely theoretical for a company that has failed to raise, because the money will not be there — which in practice means the clause hands the investor significant leverage at the worst possible moment, whether that is renegotiated terms, board control or a distressed sale. Automatic conversion at an agreed default valuation is the founder-friendly version. Ask for it explicitly, and set the default valuation when everyone is still optimistic.

Discount or valuation cap — which one actually applies?

Almost always whichever produces the lower price per share for the investor, because standard drafting gives them the better of the two. The discount bites when the next round prices modestly; the cap bites when it prices well. In the worked example above, a 20% discount on a £6 million round gave £4.80 a share while the £4 million cap gave £4.00 — so the cap applied and the effective discount was 33%, not 20%. The practical implication is that a cap costs you most precisely when things go well. Model the conversion at several plausible round valuations before signing rather than accepting the headline discount as the price.

Should the loan notes carry interest?

Push back on it. On a genuine bridge, interest that converts into equity is not a return on cash — it is extra dilution that compounds the longer the next round takes, which is exactly when you can least afford it. Eleven months at 8% on £150,000 added £11,000 to the converting sum in the example, issuing 2,750 additional shares. Interest also confirms the instrument is debt, which is one of the reasons a note cannot carry SEIS or EIS relief. If the investor wants a coupon, negotiate a lower rate, or agree it is repayable in cash rather than rolled into the conversion.