Small Business Bridge Loans
A business bridge loan is defined as a short-term loan or other type of funding that provides the capital a business owner needs to cover immediate expenses and gives the business owner enough time to locate a longer-term answer to their company’s financial situation.
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What is a business bridge loan?
A business bridge loan, or commercial bridge loan, is short term business financing that helps businesses meet their immediate needs for additional capital before the business can secure long-term outside funding. Bridge loans are often used to clear obstacles to revenue production to either increase business value or decrease business liabilities.
A bridge loan offers immediate cash that can help businesses take advantage of time-bound opportunities. However, like all business funding options, bridge loans are most beneficial when they are fully understood.
Although commonly used to fund commercial real estate purchases, business bridge loans are a highly specific type of financing that can be applied to a range of financial situations. They may come with relatively high interest rates, short repayment terms, or collateral requirements such as inventory or property. These loans are good options for businesses that need a short term cash injection and know that they will be able to meet quick repayment terms. Once dispersed, the loan can be accessed by individual owners or companies to meet their obligations.
As they are a temporary funding option, business bridge loans have also been termed as swing financing, or gap financing.
When to Use a Bridge Loan
Bridge loans can be useful in most situations where businesses need cash to meet immediate short-term goals.
One way small businesses use bridge loans is to raise more money. Commercial bridge loans can make sense when a company is trying to gain investment or has a pending round of fundraising.
If a company is raising a round of equity financing, it might not be able to access those funds for a period of months while the deal is still being worked out. A bridge loan provides the working capital the company needs to get through that period until the fundraising is secured.
Bridge loans can also be used to pay for operating expenses.
A small business might consider a bridge loan to keep the company solvent and able to pay its bills during a time when cash on hand is scarce but invoices that are outstanding are on their way to being paid off. It is also possible that the business might be in the market for new real estate, but lacks the time required to go through the process of securing a mortgage.
Many retail businesses take advantage of bridge loans to purchase inventory, which requires considerable up-front costs to cover before the company turns around, sells those products and is able to make a profit on them.
As a fast, short term form of business funding some common uses of business bridge loans include:
- Covering operating expenses while a business awaits long-term financing
- Securing the funds necessary to acquire real estate quickly
- Taking advantage of limited time offers on inventory and other business resources
- Business operating costs until long term funding is accessed
- Buying property while waiting for existing property to sell
- Buying property in an auction
- Funding property development needed to gain a mortgage
- Address seasonality
- Recover from outside economic factors such as supply chain slow down
Learn more about how to get a bridge loan for business acquisition.
Types of Bridge loans
What types of bridge loans are there?
Bridge loan funding is often tailored to meet the exact cash flow needs of the borrower. For this reason the loan structure may take shape of various financing options. There are two basic types of bridge loans -- open and closed.
1. Closed Bridge Loan
Closed Bridge Loan, provide repayment terms that are agreed to upfront.
A closed bridge loan is available for a set term, or time frame. As the term is already agreed to on by both parties, this type of loan is more likely to be accepted by lenders. Closed bridge loans gives lenders greater certainty about the loan repayment. This can be an option for small business owners with bad credit, while it also may provide lower interest rates than an open bridging loan.
2. Open Bridge Loan
The repayment method for an open bridge loan is undetermined at the initial inquiry, and there is no fixed payoff date. In a bid to ensure the security of their funds, most bridging companies deduct the loan interest from the loan advance. An open bridging loan is preferred by borrowers who are uncertain about when their expected finance will be available. Due to the uncertainty on loan repayment, lenders charge a higher interest rate for this type of bridging loan
3. First Charge Bridge Loan
A first charge bridging loan gives the lender a first charge over the property. If there is a default, the first charge bridge loan lender will receive its money first before other lenders. The loan attracts lower interest rates than the second charge bridging loans due to the low level of underwriting risk.
4. Second Charge Bridge Loan
For a second charge bridging loan, the lender takes the second charge after the existing first charge lender. These loans are only for a small period, typically less than 12 months. They carry a higher risk of default and, therefore, attract a higher interest rate. A second charge loan lender will only start recouping payment from the client after all liabilities accrued to the first charge bridging loan lender have been paid. However, the bridging lender for a second charge loan has the same repossession rights as the first charge lender.
Open vs Closed bridge loans, which is better?
closed bridge loans offer much better rates and are more likely to be accepted than their open counterparts.
Bridge loans are not supposed to be used as a long term finance solution – typically they have much higher rates and a max term of around 12 months. Because of this, the security of a closed bridging loan, where the lender knows you have a way of repaying the lump sum, is attractive and you are more likely to get a better deal.
Open loans will have higher rates, and while you may not need to have a clearly defined exit strategy, you do need to know how you expect to get the money you need to repay the loan. Unlike a typical mortgage, you cannot simply pay it off bit-by-bit every month, so think carefully before applying.
Open bridging loans are very common with borrowers who are relying on the sale of a property to generate the money they need to cover the loan.
Repaying Bridge Loans
Variations in bridge loans are typically related to the wide range of terms that lenders may extend to borrowers based on the borrower’s creditworthiness and financing needs. Therefore the greatest differences between bridge loan types is often found in the terms of repayment.
Aspects of bridge loans that may change based on repayment terms include:
- Term, or the duration available to borrowers for repayment
- Interest rate
- Payment terms, or the frequency of repayment
- Interest-only payment
- Fully-amortized payment
Read our article on interest only loans here.
Interest repayment on bridge loans can be handled in one of several ways. While some lenders require borrowers to make monthly payments, others may prefer lump-sum interest payments that are made at the end of the loan term or are taken from the total loan amount at closing.
For example, consider a small business owner who has to negotiate new supply chain partnerships and needs $25,000 to secure contracts including production, transportation, storage and delivery. This business owner then goes to a lender to borrow $25,000, knowing that reopening the supply chain and the sale of goods will create enough revenue to pay off financing and turn a profit and partner with larger investors.
The first lender offers a $25,000 interest-only bridge loan for six months at an interest rate of 5%. Under this repayment plan, the borrower is responsible for paying about $104 in interest each month ($25,000 loan principal x 0.05 interest / 12 months). In this arrangement the business owner will pay the principal balance with proceeds from the investor when that partnership is finalized.
However, a second lender may offer the same business owner a one-year amortized $25,000 bridge loan at the same interest rate. Here, using full amortization creates a more traditional repayment structure for the loan. The business owner will be able to keep all capital from the investor. However, the payments will include both the interest and principal balance. The monthly cost for this loan would be $2,140 per month.
Bridge Loans vs other Alternative Business Funding
Bridge loans work by providing short term cash flow quickly. So, the term ‘bridge loan’ describes the use of short term immediate funds, as opposed to the structure of the funding product itself. If for this reason alone, many short term funding options provided by alternative lenders may be described loosely as bridge loan financing.
Since bridge loans describe short term funding options, they are easily contrasted by long term loan options.
Bridge Loans vs Long Term Funding Options
To weigh bridge loans versus longer-term funding options businesses will need to assess their immediate operational needs versus long term financial strategy and investments.
Typically, larger loan amounts are assumed as taking longer to pay off. For this reason short term loans are often associated with relatively smaller, or more regular, expenses.
Longer-term business funding is often associated with traditional banking lenders. These loans generally come with longer repayment periods or lower interest. But bank loan applications can be complex, time consuming and more strict than those offered by alternative lenders. For these reasons long term funding is a good fit for large, planned expenses.
While these loans are harder to get for small businesses with less than perfect qualifications, they can be an asset for those who do qualify.
If your business intends to carry smaller debts into its long term financial considerations then the best option is to refinance the smaller business loans into a single long term business loan program. The practice of refinancing is common in consumer banking and is often used to manage student loan, credit or mortgage debts, among others. When taking the refinancing route, it is important to note that certain long term financing solutions may come with restrictions on what the funds can be used for.
With these options in mind, choosing short term business bridge loans is often the result of immediate business opportunities, such as expansion, or imminent challenges, like increased supply chain costs.
Working capital and business bridge loans
Working capital is a common form of business bridge loan. As a financial metric, working capital is a measure of liquidity, or cash, that is available to pay for business expenses. Business expenses may include payroll, taxes, inventory, updates to a storefront, cost of production, supply chain and delivery, among others.
Each expense related to the operations of a business is a potential reason to seek short term financing for working capital.
Working capital is often provided in the form of a bridge loan because bridge loans are structured to provide the funds businesses need immediately. In the end these funds are used to continue offering customers the goods and services they need.
Business Bridge Loan versus Traditional Small Business Loan
Business bridge loans and traditional small business loans are not mutually exclusive, meaning that receiving one type of funding does not stop a business from receiving the other. In many cases, the best case scenario involves businesses using a combination of short-term bridge loans and long-term traditional business funding to meet their financial goals.
Business bridge loans offer faster application processes and the ability for borrowers to meet short term goals. They also come with higher repayment costs, meant to encourage the borrower to pay off the debt quickly. Traditional loans have longer application processes, are intended for larger sums of money, longer repayment periods, and often have lower interest rates.
Business bridge loans are used to generate capital for immediate use and are structured to be paid back relatively quickly by the borrower. In this way business bridge loans are similar to personal bridge loans.
For example, a common use of personal bridge loans is in providing a mortgage down payment. Down payments on residential properties often vary between 12 and 20 percent of the total property value. Depending on the property this may be a large sum of money. Would-be home owners can turn to personal bridge loans as a source of outside revenue to help them meet the required down payment amount. With the money for downpayment in hand, the home-buyer can then secure a mortgage to pay for the home.
Down the line, the home-owner may refinance the property to consolidate the loans (short-term bridge loan, and long-term mortgage loan). By consolidating the borrower has the opportunity to decrease the total cost of the money borrowed.
For businesses that are expanding or buying property, borrowing a bridge loan to secure a greater amount of funding or investment works in the same fashion.
Businesses seeking investment offer a common example of using short term bridge financing to secure long-term traditional funding. Businesses that are seeing investment will often conduct an assessment of their financial assets and liabilities. Savvy businesses may use short term bridge financing to address or pay off financial liabilities. By decreasing the amount of liabilities the business has, the valuation increases, allowing the business to justify a larger investment. Once the investment is secured, the business can use that capital to pay off the short term financing.
Getting a Business Bridge Loan
Bridge Loan Requirements
What is required to apply for a business bridge loan?
To apply for a business bridge loan, business owners will need to complete loan application documentation, to provide credit history and to show proof of the business’s financial performance.
Here is a list of documents that may be required to apply for a commercial bridge loan.
Business bridge loan required documents list:
- Completed loan application
- Background information of borrower(s)
- Value of property (if applicable)
- Business credit score
- Personal credit score
- Sources and uses of funds
- Business liabilities or expenses
- Business bank account statement
- Proof of insurance
Bridge Loan Costs
Bridge loans are a convenient way to obtain temporary financing. However, this type of financing can be more expensive than traditional lending.
Bridge loans often have a larger range of acceptable credit and greater options to prove the business’s capacity to repay outside funding. The greater flexibility of bridge loans comes with a wider range of repayment costs, or rates.
Bridge loan rates can range from 6% to 30% of the principal loan amount requested. These rates can be significantly more expensive than traditional bank loans, which range between 2% to 7%.
While bridge loans can be classified as open or closed, the terms will always depend on your creditworthiness, size of the loan, and the financial situation of your business.
In addition to paying interest on the bridge loan, borrowers must pay closing costs and additional legal and administrative fees.
Closing costs and fees for a bridge loan can range from 1.5% to 3% of the total loan amount and may include:
- Appraisal fee
- Administration fee
- Escrow fee
- Title policy costs
- Notary fee
- Loan origination fee
To avoid some of the closing costs associated with in-person business and revenue verification, business owners can look to digital lenders for bridge loan solutions.
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