Fast Funds for Fast Growth: A Guide to Bridge Loan Financing

Business owners often need short-term financing to grow their business or meet regular expenses. A bridge loan is a short-term loan that helps smooth out cash flows or serves as temporary financing while longer-term financing, capital infusions, or asset sales occur. Learn more about bridge financing, what to watch out for, and how to compare bridging loans.

When Should You Use a Business Bridge Loan?

A business bridge loan is a short-term loan that provides capital to cover immediate expenses until longer-term financing is secured. Here's how it works.

For a small business owner, any interruption in liquidity can be a massive problem for their business. Instead of taking out a personal loan, bridge loans offer a lifeline to entrepreneurs who need a financing solution to get from Point A to Point B and don’t have the cash on hand.

Business owners may need to secure a bridge loan for working capital, to complete an acquisition, or to obtain new equipment. According to the U.S. Chamber of Commerce, these loans can be critical to a business in a cash-flow lull when it has yet to get the longer-term financing it needs to pay expenses.

Bridge loans can also make sense when a company is trying to gain investment, is making property purchases, or has a pending fundraising round. These loans are also a good choice for property investors or if your business needs to make renovations to its location. If a company is raising a round of equity financing, it might not be able to realize those funds for months while the deal is still being worked out. Bridge financing provides the working capital the company needs until the fundraising is secured.

Many retail businesses take advantage of bridge loans to purchase inventory. Retail businesses often require considerable up-front costs to stock storefronts until customers make purchases. As it converts inventory into revenue, the retailer can repay the loan with interest.

What Makes a Business Bridge Loan Unique?

Bridge loans typically provide quicker access to cash while waiting for permanent financing. While a longer-term loan, capital infusion, or asset sale may take time, a business bridge loan has a less complicated application process without the in-depth underwriting of traditional loans.

The downside is that the interest rates can be higher than conventional financing. Borrowers usually also pay higher fees on these short-term loans. While these loans can be more expensive, business owners are willing to make this tradeoff to secure quick funding. These loans typically have a shorter duration of 12 months or less.

Interest rates on bridge loans from a private lender can range widely based on the lender. Origination fees are expressed as “points,” with each point representing one percent of the loan amount. A $100,000 loan with three points charges a $3,000 origination fee. Lenders may also add fees for UCC-1 filing, loan processing, underwriting, and other facets of the process.

Is a Bridge Loan a Good Idea For a Small Business?

Bridge financing can provide helpful access to cash for your business. Here are a few situations where it makes sense to use temporary financing.

• Meet payroll or payroll tax requirements. Staying current on payroll and the associated taxes is crucial to avoid issues with employees and unnecessary penalties from government agencies.
• Business expansion. A short-term loan can provide extra funding while you expand your business until associated revenues increase. It can also help to acquire equipment or real estate until permanent financing is approved.
• Overcome seasonal lulls. Many businesses suffer cash flow issues during the off-season. These loans can bridge the gap between peak revenue periods for your business.
• Working capital needs. If a business needs extra cash to pay bills while waiting on customer payments, a working capital loan is a good option for bridge financing.
• Recover from an emergency. Unexpected expenses can limit your cash flow or present larger bills that need to be paid. For example, a restaurant whose basement flooded during a massive hurricane will need to get back on its feet quickly to stay in business.

Advantages and Disadvantages of Bridge Financing

Advantages of a Bridge Loan

• Rapid funding: Bridge loans provide access to funds needed by business owners. Instead of waiting months for capital, the borrower can get funding much quicker.
• Short terms: A lender makes these loans with the understanding that they will be paid off within a year or less.
• Ease of application: A small business bridge loan application may be as brief as a single page.
• Choice of repayment methods: The borrower can repay the loan early or once the long-term financing is in place.
• An opportunity to build a better credit score: Making payments on time can boost your FICO credit score. Increasing your personal credit score can improve your odds of getting a business loan on better terms in the future.

Disadvantages of Bridge Financing

• The challenge of securing the loan: Traditional banks may not approve borrowers with bad credit, a lack of experience, or insufficient profits.
• Terms of a business bridge loan are not cheap: Interest rates and transaction fees for these loans can be expensive. The high cost of this money may not be worthwhile for some borrowers.
• Risk: Will the money you borrow jumpstart your business enough to justify the cost? Not only do you have to overcome the costs of the loan, but you must grow your business enough to afford permanent financing. If not, you risk defaulting on the loan, affecting your personal and business credit history.

Secured vs. unsecured bridge loans

When taking out a business bridge loan, you'll decide between a secured loan and unsecured financing. Secured bridge loans are backed by company assets valued at or above the loan amount. If you default on the loan, your lender will seize the assets to repay the balance.

Unsecured bridge loans use your credit score and income to support the loan. While the loan is not secured by a specific asset, lenders may require a general UCC-1 filing against business assets and a personal guarantee by the company owners.

Sources for bridge funding include banks, credit unions and other private financing companies. The lender that funds the loan may be an option for permanent financing. They're familiar with your finances, and a good payment history can reassure them that you'll stay current on a larger loan. Returning to the same lender with future financing requests could enhance the likelihood of a borrower securing more favorable loan terms and interest rates.

It’s important to know that many bridge financing deals are made through hard money lenders instead of credit unions or commercial banks. Hard money lenders are less well-known to most business owners, but they tend to accept all borrowers. Working with them can carry unique risks since they are not regulated like traditional lenders.

Compare Bridging Loans

Bridge financing can be separated into four different types: open bridging loans, closed bridging loans, first-charge bridging loans and second charge bridging loans. Let's compare these fast-bridging loans to help you decide the best type of financing options for your business.

A closed bridging loan is available for a predetermined time frame. This type of financing is advantageous to the lender, who has a better chance of seeing the loan repaid on time with no issues. Closed bridging loans usually involve interest rates that aren’t as high as open bridging loans. Any loan with a clearly delineated “exit strategy” is considered a closed bridging loan.

Open bridging loans do not start with clearly defined repayment methods or a hard payoff date. Lenders often deduct the loan interest from the advance on the credit as insurance on the security of their funds. Borrowers have more of an upper hand with this type of financing than with closed bridging loans. However, open bridging loans typically have higher interest rates than closed bridging loans.

With a first charge bridging loan, the lender is in the driver’s seat. Failure by the borrower to repay the loan at the specified date gives the lender the option to repossess and sell the assets securing the loan. If there's a default, the first charge bridge loan lender will get its money before other lenders do. This type of loan must be repaid on time in full to avoid the lender taking possession. According to bridging.com, “If even a small portion of the loan is left outstanding, the lender has the option of reclaiming and selling the property in order to make their money back.” Interest rates on first charge bridging loans are relatively low.

Second charge bridging loans involve more than one lender. This method utilizes a secured loan in which short-term lending is provided toward something already secured with a “first charge.” The second charge lender is in a subordinate position to the first charge lender in case of a default. These loans carry a higher risk of default, so their interest rates are higher.

Is a Bridge Loan Right for My Business?

Ultimately, a business owner’s likelihood of qualifying and being accepted for a bridging loan will come down to their ability to pay that loan off on time. Lenders will review the borrower’s credit history, their financials and bank accounts, and the reasons for applying for a loan in the first place.

Some businesses need a bridge loan simply because they are waiting on unpaid invoices, while others need money while awaiting permanent financing, an equity infusion, or an asset sale. Deciding if this loan type is right for your company comes down to weighing the funding costs against the benefits your company will see. To help your small business cover short-term expenses, these short-term loans could be a smart investment in the company’s future.

Frequently Asked Questions (FAQs)

What is the Downside of a Bridge Loan?

Bridge loans typically have high interest rates and fees. While these loans offer short-term finance solutions for business owners, you must evaluate the costs to decide if they are worthwhile.

How Much Can You Borrow in a Bridge Loan

The maximum loan amount varies by lender, your credit score, and your company's profitability. Because these loans have such high interest rates and fees, it is wise to borrow only what is necessary to avoid extra financing costs. If you're a homeowner, you can borrow up to 80% of your current home or the price of a new property.

Is It Hard to Qualify For a Bridge Loan?

Many short-term loans are offered by hard money lenders instead of traditional banks. Hard money lenders usually have lower underwriting requirements, which allows them to approve loan requests that would be denied elsewhere. However, they tend to charge high interest rates and fees to account for the increased risk.

What is the Interest Rate for a Bridging Loan?

Interest rates vary depending on the amount borrowed, repayment terms, and your creditworthiness. Hard money lenders often charge anywhere from 8% to 12% or more. Additionally, they typically charge origination fees of 2 to 4 points, which is a percentage of the loan amount.

Can You Pay Off a Bridge Loan Early?

Yes, you can pay off your loan early. Keep in mind that some lenders may charge prepayment fees if you repay the loan too quickly.

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