When To Invest In Extension Or Bridge Rounds

Startups that raise multiple rounds of capital are expected to follow a certain path. It goes like this:

• Series Seed (typical raise: $300,000 to $5 million)
• Series A ($3 million to $30 million – often when the first “institutional” VC money comes in)
• Series B (varies widely)
• Series C (varies widely).

After that comes the Series D financing round and so on.

To move forward on this path, a startup must hit certain milestones along the way. To demonstrate that it has done well with previous capital raised.

So if a company raises a $1 million seed round, it will have to show potential Series A investors significant progress to have a chance at securing an A round.

Each financing round should be enough to support the company for at least 12 to 18 months.

But as you can probably guess, many startups find the need to raise money in between “lettered” rounds.

For investors, it’s critical to understand why a company is raising “extension” or “bridge” funding (as in a bridge between rounds).

Only then can we judge if it’s a rare opportunity or a likely dud.

Good and Bad Extension Rounds

There are many reasons why companies raise in between rounds. Today, we’re going to focus on two of the most common.

1. Not enough progress: The company simply hasn’t made enough progress and is running out of cash.
2. Prevent equity dilution: The company is doing great but wants to hold off on raising a large round until it can justify a higher valuation.

Needless to say, No. 1 is a red flag. If a company isn’t getting a lot done, it’s unlikely that’s going to change with a little more money. Of course there are exceptions, but generally speaking these situations should be treated with caution.

Companies that fall under reason No. 2 can be golden opportunities. In these situations, everything’s going great. But the founders want to raise a smaller round now – hit more milestones – and only then raise their next (larger) lettered round.

This allows the company to preserve more of its ownership equity.

Why? Because the more mature a startup is when it raises a large lettered round, the higher valuation it can achieve (allowing them to sell a smaller percentage of the company).

In a typical Series A round, for example, a startup is often selling 25% or more of the company to investors.

So if a company can raise a $2 million seed extension, instead of a larger $10 million Series A, it preserves more equity for founders, employees and earlier investors.

It can then use that $2 million to further accelerate growth before negotiating the next official round. It also allows the company to avoid the intense process of raising a lettered round, which is taxing on young companies and often requires months of work.

Oftentimes in these scenarios, VCs have already expressed interest in the company’s next round. If you’re very lucky, they’ll have already offered the startup a term sheet.

This is an ideal spot to invest. Naturally, these opportunities don’t pop up every day.

But they do come along from time to time. My investment in Uber competitor Cabify is a good example.

When I invested in August 2014, it had already raised its Series A. Traction was extremely promising, but rather than raise a larger Series B, the company did an extension of its A round.

This gave the company enough capital to accelerate growth, but not so much that it capped upside for employees and existing investors.

Eventually Cabify raised a $12 million Series B with participation from heavy-hitter Rakuten. And just this week, it announced a $120 million Series C at a $320 million valuation (also led by Rakuten).

What set up this beautiful series of events? The founders’ savvy use of a minimally dilutive extension round. The whole thing could have gone any other number of ways, but I doubt any would have been much more favorable than the path they chose.

Congratulations to CEO Juan De Antonio, Kevin Laws and the whole Cabify team.

Moral of the story: If you come across an opportunity to invest in a company that has ample interest for a larger round but chooses the minimally dilutive path, it might just be a rare golden opportunity.