A bridge loan is a short-term loan that provides immediate cash flow. Often with higher interest rates, high-value collateral, and short-term time limits, bridge financing comes with some special considerations. In this article, we will discuss how bridge loans work, and how to use them for business acquisition.
You know of a company that’s just ripe for acquisition, but your small business doesn’t have the funds for that right now. And you don’t have time to secure a traditional loan. What to do?
How Do Bridge Loans Work?
First, some bridge loan basics.
- Bridge loans are short term financing. With payback terms lasting up to one year, bridge loans exist purely to fill a financial gap (acting as a bridge): for example, until construction is complete on a new income property that you’re buying, or until you’ve established permanent financing to do so.
- Bridge loans are fast. They have short approval times and are quick to fund. They offer cash flow ASAP.
- Bridge loans come with high interest rates, various fees, and significant collateral. Bridge loans are useful for borrowers who expect to earn back more than the extra money they’re paying for the funding.
- As with any type of financing, borrowers with better credit scores or less in credit card debt may get better interest rates on their bridge loans.
- Usually, the shorter the loan term, the lower the cost of the loan.
- Typical bridge loan fees can include: commitment fees, funding fees, deal-away fees, duration fees, refinancing fees, bond underwriting fee, and others.
- Typical bridge loan collateral can include real estate or inventory.
There are 2 types of bridge loans: closed bridge loans and open bridge loans.
- Closed bridge loans already have repayment terms planned, with funds lined up to pay back the bridge loan before (or right at) the end of the term.
- Open bridge loans do not have funds already lined up to repay it at the time of borrowing.
Using Bridge Loans for Business Acquisition
A business acquisition loan allows you to:
- Purchase another business
- Acquire or open a new franchise location
- Buy out a partner in a business you presently co-own
Securing a bridge loan may allow you to win an acquisition bid, expand your current number of locations, or take over your business partner’s equity. It not only offers your business a short term solution until you can get longer-term financing, but with the right strategies, you can also leverage your gap financing in any associated negotiations.
How to Effectively Use Bridge Loans for Business Acquisition
Before applying for a bridge loan, ask yourself some questions:
- Will this risk pay off? While business acquisitions can move quickly, some acquisitions are better left done in the future when your business is more stable. Bridge loans come with steeper fees and significant collateral. Will those be worth the trade-off?
- Is a short-term solution what you truly need? Bridge loans provide immediate access to funds, but being unable to fulfill the repayment terms can rack up a lot of debt for your company.
- Do you have long-term financing options ready for later? Unless your acquisition will guarantee profit, you’ll have to figure out a way to have working capital lined up. You can explore traditional bank loans, medium-term loans, SBA loans, and other loan programs for small business owners.
Last Considerations On Small Business Owners And Bridge Loans
Once you’ve decided to say yes to a commercial bridge loan . . .
Work with a lender that’s willing to move as quickly as the rest of the contract. Commercial real estate transactions can be very hurry up and wait. You want someone experienced in business loans and invested in the “hurry up” part.
Check to see whether the bridge financing comes with prepayment incentives. Those will help you save money if you pay the loan off early. However, also check to see whether the loan comes with a prepayment penalty — extra fees you’d incur for paying it off early.
When negotiating fees, make sure there is no overlap. As an example, the bond underwriting fee could be overlapped by the refinancing fee if the bond offering is done by the same bank that issued the loan. Read all the fine print: As with all other matters financial, you can incur all kinds of extra fees along with your monthly payments. Ask questions when you don’t understand.
Be sure to borrow enough as a cushion in case of any extra costs or financial surprises. It is better to be overprepared than underprepared.