December 7, 2018 | Last Updated on: June 28, 2023
A bridge loan is a short-term loan, up to one year, used until a person or company secures permanent financing or removes an existing obligation. Bridge loans have relatively high interest rates and typically require collateral, but they provide an immediate influx of cash to your business to meet current outstanding obligations.
Bridge loans are all about speed of funding. They don’t encounter the lengthy approval process that more traditional, long-term loans go through. Bridge loans typically cut the standard waiting time by more than 100% and give your business the cash flexibility it needs to continue operations. In some instances, capital can be in your bank account within 24 hours.
There are lots of cases where a small business could use a bridge loan. If cash flow is tight, a bridge loan can help to tide the company over until large outstanding invoices come in. Or if the company is looking to acquire a new piece of real estate but doesn’t have the time to go through the whole mortgage process right away, a bridge loan can fill in the gap.
Another typical example of when a business would use a bridge loan is during a round of fundraising. Let’s say Company X is currently raising a round of Series A equity financing that isn’t expected to close for another eight months. How can this business meet its current obligations, such as payroll, rent, and stocking inventory, in the interim? A bridge loan will provide the working capital necessary to get Company X through the next 8 months until the Series A fundraising is closed and secured.
The most common scenario for a bridge loan is for a company currently waiting for or seeking longer term financing to solidify itself. But, there are a variety of scenarios a bridge loan can benefit your small business.
The most important thing to remember is that bridge loans are SHORT-TERM loans taken on to meet immediate & urgent business expenses. Ultimately, the borrower will pay off the bridge loan quickly, either through refinancing or another source of capital, because of the rates & high risk associated with bridge loans. Don’t pursue a bridge loan if you don’t intend on paying it off within a short time frame or are worried about finding a long-term lender to help you refinance. These loans are not meant to sustain your business for an extended period of time. They are meant to provide quick and immediate access to funds to address any issues your business may be facing in the short-run.
Another time in which bridge loans are advisable is in the wake of a natural disaster. In many cases, the U.S. government’s Small Business Administration, along with state governments, will offer businesses in areas impacted by natural disasters low-interest bridge loans. This is the one exception to the fact that bridge loans tend to have much higher interest rates than regular loans. A recent example of this can be seen from this past October, when in the aftermath of Hurricane Michael, Florida Governor Rick Scott activated the Florida Small Business Emergency Bridge Loan Program. Another example of emergency bridge loans, along with other loans, being offered can be seen in light of the current devastation facing large parts of California as a result of the raging wildfires. Presently, the U.S. Small Business Administration is offering emergency loans to the businesses who have been impacted.
This may be the most important aspect of choosing a bridge loan, as the main differentiator between a bridge loan and a traditional loan is the time it takes to get funds. You’re going to have to operate within the constraints of your current cash flows. Let’s say you only have 2 months of operating cash flow as a cushion, you might be fine with choosing a bridge loan that isn’t as quick to fund but provides relatively favorable terms. If you have a week left of operating cash flow, or only a few days to close the deal on a new real estate opportunity, an expedited bridge loan will be your top consideration. Because of this quick to fund requirement, bridge loans are synonymous with alternative lenders who can bypass the months and months banks will take with your application. However, you should be prepared to deal with higher than expected interest rates, especially the shorter the time frame you need to secure funds.
Bridge loan fees are generally going to be higher than what you’d get with a normal loan. Again, this all has to do with the immediacy and flexibility of the lender in providing this short-term financing. In addition to the current rate, there are typically upfront fees as well as a backend “success” fee after retirement of the loan. Bridge loans should not be compared to market rates and other alternatives. Rather, bridge loans should be thought of in terms of the long run gains you are going to realize in your business because this influx of instant cash is going to allow you to continue operating or to purchase something you wouldn’t otherwise have the money to buy.
Typically, bridge loans will come with prepayment incentives. Saving money for paying it off early is essentially the whole point of a bridge loan. You’ll want to check whether your bridge loan comes with a prepayment incentive, typically in the form of a prepayment discount or by avoiding the extra accrued interest.
At the very least, bridge loan providers will ask for a first position lien on any business assets that can be used as collateral. In addition, a personal guarantee may sometimes be required to ensure the intention of the business owner to pay off the loan in good faith. Work with your relationship manager to ensure you know all of these conditions before you start the process.
Repayment terms are going to vary based on the position that your business is in entering into the bridge loan agreement. By definition, your repayment terms can vary from a few weeks to up to a year. Where the money is going to come from to pay off your bridge loan has a considerable effect on how your lender assesses your risk. When bridge loans are used simply because of timing the lender is confident in the source of repayment and the risk will be considerably less. For example, your business doesn’t have enough cash on hand to make an opportunistic purchase, so you take out a bridge loan to cover this expenditure. You will have it repaid by next month and you’re not relying on any business improvements. In the case of a business taking out a bridge loan to simply cover operating expenses, the source of repayment is reliant on the business improving its profits. This is much riskier both for the lender and the lendee.
Like any type of financing, once you understand how a bridge loan can help your business expand or improve operations, you should be ready to put it to work for you. Just because it’s available doesn’t always mean it’s the best solution for your current needs. But knowing that bridge loans can help you cover any gaps in your cash flow or financing plans, they can be a great tool in your proverbial financial toolbelt.
