The pros and cons of bridge financing 

Bridge financing offers several benefits to businesses and entrepreneurs. They are particularly popular in real estate, where they can be used to fund auction purchases, ground-up developments, residential investments, and refurbishments. However, any company that has a solid credit history and market position can apply for a bridging loan to fund their growth.

The pros of bridge financing

One of the most significant props of this type of financing is that bridge loans are relatively easy to obtain. The application, approval, and funding process is faster than that of a traditional loan, so you can access your funds more quickly and use them to purchase inventory or equipment or meet your payroll. This also means that you get an advantage over other bidders and competitors because you can close faster.

Bridging loans also allows business owners to access short-term financing without having to relinquish control of their company. This solution doesn’t require you to turn to partners and give up authority.

Lastly, a bridging loan can help you navigate long-term payment cycles and handle cash flow problems – an issue that many startups have to deal with on a regular basis. Any business, no matter how healthy, can face money troubles at some point. With bridge loans, you can get cash to complete your projects and afford other operating expenses while you wait for your payments and profits to come in.

The cons of bridge financing

Of course, bridging loans also have disadvantages for businesses. The main one is, pershaps, that payments tend to be large. Because most bridge loans have a duration of about 12 months, this means you will need to make bigger monthly payments to cover the bridging loan cost. If you’re late on your payments, you might also face high-interest rates and penalties.

Most companies that take a bridging loan are expecting a future payment – especially if they are close to finishing a job or launching a product or service. However, if things go wrong and you can’t access those proceedings, you might find yourself immersed in significant debt. And if your debt is higher than your income ratio, your business could be at risk. Fortunately, this is quite an uncommon scenario.

Lastly, due to how bridging loans work, you will most likely face high-interest payments no matter where you get the funds from (at least when compared to traditional loans’ interest rates). The best remedy is to always make sure you always have a repayment strategy. You should also keep in mind that there might be extra fees when you use a bridging loan, such as origination fees, early termination fees, and closing costs.

When to use bridge loans

Although the concept of bridge financing is relatively straightforward, it’s always best to know when and how to use one to get the most out of the funding they will provide.

You should always consider this option carefully. The interest rates when you use a bridging loan are high, and there are a lot of provisions that are designed to protect the lender because the risk for them is quite high. So how do you determine when your company should apply for a bridging loan, and what can you do to ensure you will be able to pay back in time?

Imagine, for example, that your company has secured a loan finance option that consists of three instalments. The first one is settled in six months, but your business needs the funds now because you need to cover operational costs. In this case, you could apply for a six-month bridging loan and secure the money you need to survive until you unlock the first credit tranche.

Whatever scenario you are faving, one of the crucial things to do when considering a bridge loan is to keep track of all possible fees associated with it.

How a bridging loan work: Interest rates and fees

There are several fees to keep in mind when you decide to apply for a bridging loan for your business. For instance, borrowing costs can include:

• Interest rate: This is usually the highest fee associated with a bridging loan. Venture capital firms typically charge about 20% to provide financing. This number has to do with the risk involved and can also increase if you don’t repay the loan on time. The rate should be set up at the beginning of the commitment and usually ‘steps up’ on a quarterly basis as long as there is a bridge loan in place.
• Commitment fee: To demonstrate the lenders’ commitment, there is usually a fee that is payable regardless of whether the bridging loan is funded. There is usually also a funding fee for when the bridge loan is funded.
• Arrangement fees: Many bridging loans also include an upfront arrangement fee, which can be a percentage of the loan or a fixed amount.
• Exit fee or deal-away fee: There is also usually an exit fee payable at the end of the loan. This can also be a pre-agreed fixed amount or a percentage, so it’s important to have an adequate exit strategy.
• Early repayment fee: If you redeem the bridge loan early, you might have to pay an early repayment fee.
• Alternative transaction fee: A fee for when the borrower terminates the high yield engagement letter within an agreed period with financing provided by a different bank (then the original bank needs to be compensated).
• Conversion fee: If the bridging loan is not refinanced and is instead converted into long-term financing, there can be a conversion fee imposed on the borrower.
• Other fees and costs: A bridging loan can also include legal costs (for both the borrower and the lender), admin fees, broker fees, valuation costs (if dealing with a commercial property purchase, residential property developers, residential mortgages, etc.), and other supplementary charges.

Where to find bridge financing

Private banks tend to offer competitive bridging finance rates. This type of bridging lender makes loans affordable, but banks want to know everything they can about their borrowers. The advantage of dealing with them is that they tend to respond quickly to bridging loan requests and can make decisions fast. However, just like mortgage lenders, you can also expect private banks to do a thorough underwriting process that focuses on your ability to repay the bridge loan.

Today, the majority of bridging loans are provided by non-bank lenders. There are different players, from peer-to-peer lending platforms to companies that specialize in specific markets. Typically, the rate you will be offered will be heavily influenced by the competition, so this means the more providers there are, the better a deal you can get.

Many startups prefer to exchange capital for an equity portion of their company. In this case, you can approach a venture capital firm instead of a bank and offer a portion of equity ownership. If the firm believes you will succeed and become profitable, they can offer equity bridge financing at a lower interest rate.

Another option is also to offer a portion of your shares on a stock exchange and pay off a loan after you raise money during the IPO. For example, a venture capital firm can include a convertibility clause in the bridging loan application. This way, they could convert some of the credit amounts into equity at a specific price per share.

Bridge financing: Summary

Bridge loans are an excellent way to finance acquisitions and deal with short-term liquidity requirements. These loans tend to extend for a period of about 12 months and have high-interest rates and/or are backed by asset collateral such as equity.

Bridge loans carry some risk, and this is the reason why the borrower has to pay considerable fees to access this type of funding. However, in the last years, bridging finance has become straightforward and competitive, with many attractive options available for businesses and startups.

Businesses can use bridge loans as an ideal financial option or temporary loan for companies that want to use bridging loans as a source of quick funding until they can secure permanent financing from equity investors or debt lenders.

We offer several funding options including Fundsquire’s Revenue Based Funding, Grant Advance, and R&D Tax Credit Loans. To see which bridge funding option is the correct solution for your business, get in touch with our team today.