The simple definition of a business bridge loan is a quick but high-interest credit which provides fast source of money for the struggling entrepreneur.
As the term implies, the bridge loan is used to fill in the requirement for cash to settle bills until bigger financing is obtained. Proprietors with stable cash flow and consistent monthly revenues can approach lending firms or banks. You can avail of loans payable in two, three or four months.
Bridge funds can infuse limited amounts of funds to prevent a corporate organization from losing financial resources in the midst of consecutive private equity financial deals. It helps private enterprises which are experiencing economic difficulties while in the process of looking for large investors. The mortgage can also be utilized for financing of publicly listed corporations before a public offering is made. This can sustain the firm while the offering is being evaluated by management and board of directors.
Possible Bridge Loan Sources
The bridge can come from a company or “factor” which offers immediate funds for start-ups for particular assets or accounts receivables. These should meet specific credit requirements of borrowers. The factor provides from 50 up to 70 percent of the par value of outright invoices upfront. The balance will be given to the business owner once the receivables are collected. However, the factor gets a large fee or interest rate for the bridge.
This type of mortgage is more costly compared to permanent credit arrangements. Such a loan is considered paid off when the title-holder opts to place permanent financing on the land asset. This takes place when all improvements are finished and the new occupant has moved in. Commercial Bridge Loans become useful when a business borrower finds the need for it to make possible temporary financing.
These may also be utilized for refinancing in the future or to salvage a certain piece of property from foreclosure. Advances are availed of at a time when the real estate developer is waiting for permits or authorizations to be processed. The loan is easily facilitated and involves lesser documentation compared to that of borrowing from private banking institutions. Business bridge financing that may be obtainable for a prearranged amount of time are categorized as closed credit while those that do not require specific payment dates are called open loans.
Some equity investors also give out bridge loans. The funding group can give provisional credit as advance for the closing of stock acquisition. Financing may take the form of convertible notes wherein the lender only gets the interest during the bridge period. The principal will not be settled until the long-term equity deal is completed. It can also be a combination of interest and a portion of the loan amount. This is a conversion feature that allows the lender two options. One is to ask for full payment inclusive of principal, all fees and interest charges. The other is to convert it into another equity share for a long-term package. This arrangement is ideal if the bridge is meant for three months or prospects of sales and profits have improved significantly.
Benefits of Bridge Financing
One of the upsides of bridge loans is the quick fix process. Real estate mortgages and educational loans oblige borrower to pay for a longer period of time. Lengthy payments make it more difficult for the person who availed of the loan. It can lead to additional financial problems as penalty fees are bound to increase. Bridge loans should be settled in full by the time bigger financing is obtained.
This translates into another advantage since you are free to select from repayment options. Amortizations are scheduled within the limited duration given to you. Prompt settlement can possibly improve credit ratings significantly and allow you to be eligible for long-term loans that otherwise you will not be qualified to get. In this case, part of the permanent loan can be allocated to pay the bridge completely.
Nonetheless, lending facilities do not really have formal guidelines when it comes to qualifying for this short-term financing compared to other programs. Lenders take the risk by charging excessive interest rates or ask for certain collateral. Companies usually choose operating capital and mortgage bridges. For example, the mortgage on the office space is outstanding before the corporation finds a fitting replacement long-term credit. It looks for a bridge to take care of the present mortgage. When it gets the new loan, it pays off the short-term funding.
Prepayment is another plus since the company can settle the loan at any given period without incurring penalties. This is unlike the commercial mortgage that imposes fees for early payment. Thus, it is a variable alternative for enterprises considering extended financing. Incidentally, creditors may be keen to extend the bridge based on business dividends. Entrepreneurs must be capable of establishing outstanding credit history, steady record of profitability and robust sales performance. This means that the business owner has the capacity to pay back within a short period.
In case your revenues do not satisfy the lending company’s preconditions, you can offer security as a guarantee for payment. Possible collateral include equity in real property, office equipment and capital assets. The positive aspect is that the lien grants the lender incentive it requires to approve your proposal. The drawback is you can lose some of your assets if you end up with a default.
There are other possibilities such as investors especially if there is significant equity financing being worked out. There are multiple processes wherein this scheme can be arranged. It may be granted on the basis of imminent infusion of capital. It is even probable to secure the bridge loan on the merits of combined investments. This is the case if the equity fund comes from more than one source.
Potential Downsides of Bridge Loans
The biggest advantage of this bridge can also be its major disadvantage. Amortizations can be hefty due to the quick repayment terms. This is not a problem if the borrower is expecting funds to come in during the payment period. However, it can be a headache for the cash-strapped business owner. Late fees and interest charges will make it harder for you to complete settlement on time.
One solution to address this issue is to give back the loaned amount as soon as permanent funding is obtained. Yet, this has another shortcoming. Every month that the loan is not repaid means accrual of interest. The result is payments which may be three or four times the principal amount borrowed. Another negative aspect of the bridge loan is that it depends on the availability of the long-term credit. In case the lending firm encounters a major financial problem, the transaction may not push through. This leaves the borrower struggling to find an alternative to cover the loan. You can opt for a take-out but this debt situation can lower your credit rating which in turn will make it harder for you to obtain additional financing.
Just as bridge loans basically afford entrepreneurs temporary reprieve to deal with investment or working capital requirements, it is imperative to pinpoint a source that will take care of the loan on or prior to maturity. Since you are given time to resolve the issue, it is not really necessary to have the actual funds ready. All you need is a viable plan for acquiring the funds. Unfortunately, the risks are higher compared to conventional solutions. Lending agencies are quick to get hold of collateral assets or resort to foreclosure right away.
It really does no matter if you are engaged in a start-up enterprise or your business is growing fast. You will always need a steady supply of cash. Negotiations with investors can take forever which is not suited for your venture.
Bridge loans can be the best option especially if you are in a hurry. In short, you need the money for an urgent acquisition, payment of lease or additional capital outlay. This is not a new idea having been spurred by the concept of angel investors. It is ideal because of the simple process as well as quickness of processing and approval. The bridge financing can be executed in a few hours or several days if the requirements are waiting to be accomplished. All the lender has to do is decide and prepare the check.
Everything can be documented in a single page. It is simply an agreement between two parties. The main aspect here is to borrow money and terms are decided later on. Nevertheless, the loan starts earning interest even if the conditions for the equity deal have not been fully discussed and modified. In other words, the bridge can be a guarantee or contract to change the borrowed amount of money into company stock. The price can be finalized afterwards. It actually bridges the time between when the company (or borrower) needs the money which of course is immediate and the moment professional investors can reach a deal for fair assessment by the stockholders.