What is Bridge Financing, and How Does It Work? » Small Business Bonfire

Bridge financing can be an excellent option for businesses looking for quick and easy access to capital. But what is bridge financing, and how does it work?

In this article, we will discuss what bridge financing is and how it works

What Is a Bridge Loan?

Bridge financing is a type of loan used to cover a short-term funding gap. It is typically used by businesses that need to finance a large purchase or project that they cannot cover with their current cash flow. 

How Does Bridge Financing Work?

When a company is looking to expand or make a significant investment, it may not have all of the necessary funds on hand. In these cases, they may seek out bridge financing.

The company will work with a Bridging Finance Broker, who will provide the borrower with a loan secured by their existing assets.

These assets can include: 

  • Real estate: This can include the equity in the borrower’s home, commercial property, or land.
  • Personal assets: These can include things like jewelry, art, or vehicles.
  • Business assets: This can include accounts receivable, inventory, or equipment.
  • Other collateralThis can include things like life insurance policies or patents.

The loan amount the borrower can receive will depend on the value of their assets. 

Once the loan is approved, the business can use the funds to cover the costs of the expansion or investment.

When the project is complete and the company is generating revenue again, it will then be able to repay the loan.

The loan is typically for a short-term period (12 months or less) and has a higher interest rate than traditional loans.

Here are some critical points about bridge financing:

  • Bridge financing is a type of short-term loan used to cover the gap between when a property is purchased and when long-term funding is secured.
  • Bridge loans are typically used when a property is being sold, and the proceeds from the sale will be used to purchase another property.
  • The loan allows the borrower to utilize the equity in the first property as collateral for the loan.
  • Bridge loans are typically interest-only loans, meaning that only the interest on the loan is paid during the term.
  • At the end of the loan term, the borrower must either repay the loan in full or refinance it into a permanent mortgage.

Bridge Loan Example

Say your business needs $500,000 to expand, but you only have $200,000 in cash on hand.

You could take out a bridge loan for the remaining $300,000. Your existing assets would secure the loan, and you would need to repay the loan within 12 months.

The interest rate on the loan would be higher than a traditional loan, but it would give you the funds you need to grow your business.

When Should You Use Bridge Financing?

Bridge financing can be an excellent option for businesses looking for quick and easy access to capital while waiting for long-term funding to come through.

Some examples of when bridge financing may be a good option include: 

  • You are in the process of selling your business but need cash to cover expenses in the meantime.
  • You are expanding your business and need capital to cover the costs of construction or inventory.
  • You need to make a large purchase but do not have the cash on hand to cover it.
  • You are waiting for a large contract to be paid out and need funding to cover expenses in the meantime.

Bridge financing can be an excellent option for businesses expecting to receive payment from another source shortly but need access to capital in the meantime.

But it is important to remember that bridge loans are typically for a short-term period and have higher interest rates than traditional loans.

Therefore, the borrower should only use them when they are confident they will be able to repay the loan within the agreed-upon timeframe.

Before taking out a bridge loan, weigh the pros and cons and consider all your options.

Pros Of Bridge Loans

Bridge loans are a great way to get access to capital quickly without going through the lengthy and often complicated process of applying for a traditional loan.

Here are some of the other benefits of bridge loans:

  • Bridge loans can be used for various purposes, including funding renovations, expansions, or even purchasing a new business.
  • They are typically shorter than traditional loans, so that you won’t be paying interest for as long.
  • You can make interest-only payments on a bridge loan, which can help to keep your monthly payments down.
  • They can be quickly approved and funded, which can be helpful in time-sensitive situations.

However, there are also some drawbacks to bridge loans that you should be aware of:

Cons Of Bridge Loans

Bridge loans can be an excellent option for borrowers who are looking for short-term financing; however, there are also some drawbacks to bridge loans that you should be aware of:

Here are some potential drawbacks to consider:

  • They typically have higher interest rates than traditional loans since they are considered a higher risk, which can add up quickly if the loan is not repaid promptly.
  • They have strict repayment terms, which can be challenging to meet if the borrower’s financial situation changes.
  • They typically require collateral, such as equity in your home or another piece of property.
  • They may have shorter repayment terms than traditional loans, which means you will need to repay the loan quickly.
  • Bridge loans are often unavailable from traditional lenders, making it challenging to find a reputable lender.

Borrowers should consider all of these factors before taking out a bridge loan. 

How Do You Qualify For a Bridge Loan?

Qualifications for a bridge loan will vary from lender to lender, but there are some general criteria that most lenders will look for. 

  • Plan: Most importantly, when applying for any loan, borrowers should have a solid plan for how they will use the funds from the loan and repay the loan within the agreed-upon timeframe.
  • Stability: Borrowers should also have a good credit score and a steady source of income. You’ll need to prove that you have the income to make the payments on the loan. Which usually means providing tax returns and bank statements.
  • Equity: Some lenders may also require collateral, such as equity in your home or another piece of property. The equity you’ll need will depend on the lender, but it’s typically around 10-20%.

Once approved for the loan, the lender will typically give you a check or wire the money to your account within a few days.

Then, it’s up to you to use the money to pay off your debts and complete your project.

In Conclusion

In conclusion, bridge loans can be a helpful financial tool for businesses expecting a short-term cash flow shortfall.

By using a portion of the equity in their existing property, businesses can secure the funding they need to cover expenses until they generate additional revenue.

While bridge loans come with some risks, they can give businesses the flexibility and peace of mind they need to weather a temporary financial setback.

Do you have any tips for those interested in Bridge Financing to consider? Let us know in the comments below!