The Ultimate Guide to Bridge Loans for Small Business Owners
For example, let’s say that you have long-term financing set up for your business’s expansion project. This long-term financing doesn’t start until the beginning of next year. In the meantime, you need to finance the project.
If you chose to get a bridge loan, you’d take out a short-term loan that matures when your long-term financing begins. That way, you’d have access to funds to start your project while you wait for your permanent financing. Then, you’d pay off your bridge loan using the proceeds from your permanent financing.
Of course, this is just one example of one scenario. Bridge loans come with all different kinds of terms, conditions, and other considerations.
In this post, we’ll review everything you need to know about bridge loans to determine if they might be a fit for your business.
Bridge Loan Definition:
Also called bridge financing, a bridging loan, or a swing loan, a bridge loan is a short-term loan structured to provide financing until the borrower obtains permanent financing. Bridge loans are usually short-term and come due in 12 months or less. In some cases, these loans may have a term of up to three years.
Bridge Loan Terms, Repayment and Application Processes
Bridge loan terms and their application processes vary widely depending on the type of borrower and lender.
For example, let’s say you’re a residential real estate developer looking to purchase vacant land and build homes to later sell. You plan to get a construction loan, but in the meantime, you need financing to cover the purchase price of the land. Therefore, you can get this type of loan to bridge the gap.
In this case, you’ll need to work with a lender that provides bridge loans for land.
There are also lenders that provide bridge loans for startups that need cash before their next funding round. In both scenarios, the individual lenders will have specific application requirements and terms for their bridge loans
Generally speaking, though, these loans come with relatively high interest rates, short terms, and stringent collateral requirements. The application process will usually look similar to that of a term loan or personal loan. During the application process, you’ll be expected to provide the following:
- Proof of down payment
- Credit score
- Financial capacity
- Past business experience
Lastly, how you repay a bridge loan varies based on what you’re using the loan amount for. In most cases, bridge financing is structured with a balloon payment at the end of the term. However, if you’re using this financing for real estate, lenders structure it so you can pay with the proceeds of your real estate transaction.
Ideal Scenarios: When Do Bridge Loans Work Best?
Bridge loans are a potentially good solution anytime you need short-term funds to jumpstart a project before you secure permanent financing. However, there are two specific scenarios that bridge financing is the most often a great fit for:
1. Real Estate Purchases
Bridge financing is especially common in real estate. As mentioned earlier, bridge loans are often useful for developers and homebuilders. However, there are other potential scenarios in real estate that lend themselves well to bridge financing.
In fact, anytime you simultaneously purchase one piece of real estate while selling another, bridge financing can help you afford closing costs and other expenses. Homeowners commonly use bridge loans when they want to purchase a new home before their current home sells.
2. Startups in Between Funding Milestones
For startups using venture capital, bridge financing can be a powerful tool. Bridge loans allow startups of any stage to fulfill their cash needs between funding milestones.
For example, imagine your startup raises $1,000,000 in Round A funding. Also, assume your next round of funding is contingent on your company showing a profit. Eventually, you realize, this is a problem because to become profitable, you need more funds.
In this scenario, bridge financing could provide you the short-term funds you need to reach profitability. Then, you can simply dispose of the bridge loan once you’ve secured your next round of funding.
The caveat for startups is that, in some cases, these loans can be a red flag for other investors. Also, in some cases, bridge financing may take the form of convertible debt. This means that the lender is paid in stock equivalent to the money owed.
Conclusion: Is a Bridge Loan Right for You?
Unfortunately, there’s no formula that’ll tell you whether a bridge loan is the right funding option for you. Even if the numbers make sense, bridge financing isn’t the right loan option for everyone. It’s usually expensive and because it’s short-term financing, you don’t have much margin for error.
The pressure of a bridge loan coming due can cause some founders to become overly cautious. Still, these business loans can be very useful to overcome temporary cash flow problems. So, if you can pay off your loan with new financing or a large sale, it’s an option that’s worth considering.
If you’re interested in pursuing a small business loan for your business’s cash flow needs, click the link below to get your free quote:
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.