Choosing Between Bridge Financing and Venture Debt: Contract Points to Check

Hello, I'm Noriaki Asato, Representative Attorney at LegalAgent.

Consider a situation in which the board of directors has decided only on the phrase "let's get through to the next round with a bridge," while it has not yet been decided whether the actual substance is an additional investment from existing investors, a new issuance of J-KISS, or a bank loan. "Bridge" is a practical label describing the purpose of funds that carry the company until the next fundraising; it is not a legal financial product name defined in the Companies Act or the Financial Instruments and Exchange Act. Under the same label are options ranging from an additional issuance of common shares to bank borrowing, which differ completely in whether there is a repayment obligation and in the degree of dilution.

The comparison between two instruments, convertible notes and J-KISS, was covered in The Difference Between Convertible Notes and J-KISS. Even when the scope is broadened to debt-type financing through loans and bonds, and especially to the area known as venture debt, the basic axes of comparison are the same. Together with the required amount, runway, source of repayment and constraints under existing contracts, the analysis should include how matters will be handled if the next fundraising is delayed.

Organizing the Purpose of the Bridge, the Source of Repayment and the Financing Instruments

The situations in which the word "bridge" is used vary. In some cases, the company wants to secure time until it achieves milestones so that it can negotiate the valuation of the next round on more favorable terms; in others, a fundraising already in progress has been delayed and the company needs to secure funds urgently to maintain its cash flow. The former is buying time to hold the initiative in negotiations, while the latter is closer to avoiding a cash flow failure. The acceptable range of terms also changes depending on the purpose.

Before comparing the instruments, there are two matters to settle. One is the required amount and runway. Calculate, using a cash flow forecast, how many months of working capital the company needs to reach the milestones for the next round. The other is the source of repayment. For equity-type instruments, check, in addition to dilution at issuance or upon future conversion, whether cash will flow out under specific conditions. For debt-type instruments, on the other hand, it is necessary to identify before signing the contract which of the next round's proceeds, revenue or existing cash balance is expected to be the source of repayment. If the only source of repayment is "the success of the next round," then if the next fundraising is delayed, the bridge that was supposed to help cash flow will itself become a new source of cash flow risk.

Bridge instruments broadly divide into equity-type and debt-type.

Equity-type instruments include additional issuances of common shares or preferred shares and convertible equity, typified by J-KISS. As discussed in What Is Financing Through Class Shares (Preferred Shares)?, the terms of existing class shares and the differences in terms from existing investors are at the center of negotiations. As discussed in Checklist Before Raising Funds with J-KISS, when J-KISS is additionally issued by a company with existing preferred shareholders, the level of the cap and consistency with existing contracts need to be checked individually.

Debt-type instruments include convertible notes, bank loans and privately placed bonds, as well as venture debt and the capital-type loans of the Japan Finance Corporation (JFC). Convertible notes can be structured as loans, bonds and so on, and the maturity, interest and the priority between cash repayment and conversion into shares differ from contract to contract. Bank loans and venture debt share the feature of carrying a repayment obligation, but the interest rate, security and guarantees, and financial covenants differ greatly from contract to contract.

As a rule, equity-type instruments carry no repayment obligation but involve dilution of shares, while debt-type instruments, as a rule, involve no dilution but carry a fixed repayment obligation. However, this axis alone cannot determine the instrument. Even a debt-type instrument becomes a source of future dilution if warrants are attached, and even an equity-type instrument may retain features under which funds flow out upon specific events, such as cash consideration in a change of control transaction based on the call provision of J-KISS.

Points to Check in a Venture Debt Agreement

There is no established legal definition of the term venture debt. The research report (Japanese) published by the Financial Services Agency in 2025 states, based on interviews with financial institutions in the United States, the United Kingdom, Singapore and France, that venture debt is provided in multiple forms, such as loans on deeds, convertible notes, loans with share options and bond guarantees, and that its definition is not uniform either internationally or within each country (FSA-commissioned study, "Report on Research into Venture Debt Initiatives in Other Countries," pages 8 and 45). The report further concludes that granting share options (warrants) is merely "one of the options" and not an essential element, and as for security, it reports that in the United States, cases with no security, cases secured by intellectual property rights and cases with a security interest over all assets were all observed (pages 45 and 52 of the same report). Treating venture debt uniformly as "an unsecured, unguaranteed loan" will lead to overlooking terms regarding security, guarantees and warrants, which are designed differently in each transaction.

When reviewing the contract terms, read them by applying each of the following items individually.

Item	What to check
Interest rate	Fixed or floating, whether it is linked to performance, level for each period
Term	Maturity date, whether there is a grace period, repayment schedule
Repayment	Installment repayment or bullet repayment at maturity, whether early repayment is permitted and the fee
Events of acceleration	Which facts lead to a demand for repayment in full
Security and guarantees	Whether unsecured, whether part or all of the assets are pledged, whether the representative provides a guarantee
Financial covenants	Whether there are clauses on maintaining net assets, cash and deposit balances, prohibition of additional borrowing and so on, and the threshold values
Reporting obligations	Frequency and recipient of monthly trial balances, cash flow forecasts and KPIs
Use of funds	Whether there are clauses limiting use, such as to working capital or capital expenditure
Restrictions on additional borrowing	Whether prior consent or notice is required for borrowing from other lenders
M&A and change of control clauses	Whether there is acceleration or a demand for repayment in full upon a change of control
Warrants (share options)	Whether attached, exercise price, exercise period, scale of dilution upon exercise

The obligation to comply with financial covenants (such as a covenant to maintain cash and deposits) may arise immediately after the contract is signed. Also check from when the events of acceleration apply. If the next round is delayed beyond plan and the monthly cash and deposit balance falls below the covenant threshold, check in the actual clauses whether acceleration occurs automatically or upon a demand or notice from the lender, and whether there are provisions for a cure period or a waiver. Before signing, it is necessary to calculate in advance which assumptions in the business plan, if they fail, would cause a covenant breach. Where warrants are attached, checking the amount to be paid for the share options themselves and the amount to be paid upon exercise, the upper limit on the number of shares to be delivered and the issuance procedures (Article 236 et seq. of the Companies Act) is common to the issuance procedures for J-KISS.

Consistency with Existing Contracts (Prior Consent, Preemptive Rights and Restrictions on Security)

Even for debt-type financing, it is not possible to proceed without checking the existing investment agreement and shareholders' agreement. As discussed in Review Points for Shareholders' Agreements, matters requiring prior consent may include not only the issuance of new shares and share options but also borrowing exceeding a certain amount. Even for financing through venture debt or a bank loan, if it falls under matters requiring prior consent or notice under the contract, executing it without the consent of or prior notice to existing investors will be a breach of contract.

The clauses to check divide into three. The first is the prior consent or notice obligation for the borrowing itself. The second is preemptive rights: where warrants (share options) are attached to a loan, check whether existing investors' subscription rights to maintain their shareholding ratio extend to them. The third is clauses restricting the creation of security and additional borrowing in existing financing agreements. A company that has already received a loan from another financial institution may have clauses in that agreement restricting the creation of new security interests or additional borrowing (such as a negative pledge). A negative pledge clause does not necessarily prohibit all additional borrowing uniformly and may be limited to restricting the provision of security, so check across the board whether it conflicts with the security terms of the new venture debt agreement.

Dilution should be kept in mind even for debt-type instruments. Where warrants are attached, the voting ratio and other interests of existing shareholders will be diluted when new shares are issued upon exercise. The lower the exercise price is set, the more difficult it may become to explain to investors in the next round.

Branches and Risks if the Next Round Is Delayed

The situation that should be anticipated most when putting together a bridge is the branching that occurs if the next round does not proceed as planned.

Under J-KISS Post Cap 2.01, the date 18 months after the allotment date is called the conversion deadline, and after that the instrument can be exercised into common shares with the approval of holders of a majority of the total issue price. The rights do not lapse after 18 months, nor does cash repayment automatically arise. Whether to postpone the point at which conversion becomes possible, or to change other terms, is also considered in accordance with the actual terms of issue and the agreement of investors.

With debt-type instruments, the range of options is narrower. Possible individual negotiations include proposing an extension of maturity, setting up an additional borrowing facility, changing the repayment plan or conversion into shares. How to respond if the due date arrives without the next fundraising having been completed is also considered. Note that a debt whose maturity date has arrived and whose repayment is due must be repaid even without triggering the acceleration clause. Whether a delay in installment repayment leads to repayment of the entire remaining balance in a lump sum depends on the triggering conditions of the acceleration clause and the cure period, which should be checked. Because debt-type instruments carry a fixed repayment obligation, the freedom to negotiate when the next round is delayed tends to be narrower than with equity-type instruments. On the other hand, ordinary borrowing does not involve the immediate issuance of shares, so there remains room to restructure the terms by factoring the existing loan balance into the valuation negotiations for the next round. Which is easier for the company to handle depends on the relationship with lenders and investors, the certainty of the source of repayment and the headroom under the financial covenants.

The Difference Between Capital-Type Loans and Private Venture Debt

A capital-type loan is a borrowing that has a certain degree of subordination and other features and that may be treated as capital in financial institutions' asset assessments. Here I take up the JFC's "Special Loan for Strengthening Capital to Support Challenges." It is important to distinguish between being a liability for accounting purposes and the treatment in financial institutions' assessments.

When I checked the JFC's official pages on September 13, 2026, the Special Loan for Strengthening Capital to Support Challenges (capital-type loan) under the Micro Business and Individual Unit (Japanese) had a loan limit of JPY 72 million (separate facility), a repayment period of at least 5 years and 1 month and up to 20 years with bullet repayment at maturity, and a performance-linked interest rate of 3.25% to 3.95% per annum depending on the repayment period if net income after tax is JPY 0 or more, and a flat 0.50% per annum if it is less than JPY 0, with no security and no guarantor. Under the Small and Medium Enterprise Unit (Japanese), the loan limit is JPY 1.5 billion per company and the repayment period is each year from 5 years and 1 month or 6 years up to 20 years (bullet redemption at maturity). In both cases, there is a special measure under which the rate is 0.50% for three years after the loan if all prescribed conditions, such as plan formulation with the support of a private financial institution and co-financing, are met. Because the details of the program may change, if you actually consider using it, check the latest interest rates and loan limits on the JFC's current official pages.

The capital-type loan and private venture debt provided by banks and funds are both loans, but their nature differs. The JFC capital-type loan discussed here has published eligibility, use of funds and interest rate structure, but the borrower is screened on its business plan, financial condition and so on. There are special covenants such as quarterly management reports until full repayment, and upon a decision to commence legal insolvency proceedings, it is subordinated to other debts except those of equal or lower ranking for repayment. Private venture debt does not necessarily have the same subordination. By contrast, as the FSA study mentioned above shows, for private venture debt, security, guarantees, whether warrants are attached and the content of financial covenants are negotiated individually for each lender and each transaction. Even if a capital-type loan is available, it is considered in combination with private venture debt or ordinary bank loans depending on the amount to be raised and the degree of freedom sought in the use of funds. Our financing support, including reviewing venture debt agreements, is described on Startup Legal and Fundraising Support.

Frequently asked questions

Is there a contract type called "bridge financing"?

No. "Bridge" is a term describing the use of funds, namely bridging the period until the next fundraising, and it is not a legal product name under the Companies Act or the Financial Instruments and Exchange Act. Multiple instruments that differ in whether there is a repayment obligation and in the degree of dilution, such as additional issuances of common shares or preferred shares, convertible equity such as J-KISS, convertible notes, bank loans, venture debt and capital-type loans, are all used under the same label of "bridge."

Is it correct to understand venture debt as an unsecured loan without guarantees?

I do not think it should be understood that way uniformly. According to the research report published by the Financial Services Agency in 2025, in U.S. venture debt practice, unsecured cases, cases secured by intellectual property rights, and cases with security over all assets have all been observed, and the grant of share options (warrants) is merely one of the options and not an essential element of the definition. Since the terms of security, guarantees and warrants are designed individually for each lender and each transaction, they need to be checked in each contract.

Are the Japan Finance Corporation's capital-type loans the same as venture debt offered by banks?

They are different. The capital-type loan (the Special Loan for Strengthening Capital to Support Challenges) is a policy-based loan by the Japan Finance Corporation (JFC), designed in line with published requirements on eligible borrowers, interest rate structure and maximum amount. Private venture debt, by contrast, is a product whose security, guarantees, whether warrants are attached and financial covenants are negotiated individually for each lender and each transaction. When considering using it, you need to check the latest interest rates and maximum amounts on the JFC's current official pages and then compare the options according to the amount you need to raise and the degree of flexibility in the use of funds.