The Pros and Cons of Bridge Financing
The Pros of Bridge Financing:
1. It’s a Quicker Way to Obtain Financing
The application, approval, and funding process for bridge loans is typically much faster than it is with a traditional loan. Thanks to this expedited process, your business can quickly receive financing to purchase equipment, pay for inventory, or meet payroll.
Bridge financing is especially vital if you need to complete a job or are trying to bid on additional projects. Whether it’s to buy real estate or purchase another business, bridge financing gives you a leg up on other bidders because you can close faster.
2. There’s No Need to Relinquish Control of Your Business
It’s common for business owners who are waiting on cash to turn towards short-term financing through one of their equity partners. However, part of the deal they often strike is a greater stake in the business for their partner.
Bridge loans are a short-term financing solution, so you won’t need to turn to partners. In addition, you can maintain as much control of your business as possible. In this regard, it’s a win-win!
3. It’ll Help You Navigate Long Payment Cycles
According to research firm CB Insights, the second most common reason for a startup’s failure is cash flow problems. This is troublesome, because even if you’re running a healthy business, you may still be susceptible to running out of cash.
When a healthy business runs into a cash flow problem, it’s often caused by long payment cycles. For example, if you own a construction business, you might get paid at the beginning and end of a project. In the interim, you’ll still need cash to complete the project and afford other business expenses.
To solve this problem, you could use bridge financing to gain access to cash which will cover your upfront expenses while you’re waiting for payment.
The Cons of Bridge Financing:
1. Payments May Be Larger
The terms of bridge loans generally range from 3 to 18 months. Due to this, you’ll be making larger monthly payments than you would for other business financing products. If you have plenty of cash to make the payments, this is just a slight disadvantage. However, if you’re late on your payments, penalties and interest can pile up.
2. It Can Be Risky if Future Payment Falls Through
If you’ve taken out a bridge loan, you may be anticipating future payment, especially if you’re about to finish a job. Unfortunately, if you’re planning on using the proceeds from the payment you’re anticipating, and that payment falls through, you could be stuck with a large, unexpected expense. Even worse, you could find yourself with significant debt to income ratios, making it challenging to run your business.
However, this doesn’t happen often. According to U.S. News, less than one or two percent of bridge loans have issues. Still, every loan has risk, so it’s worth considering before you make any commitments.
3. There May Be Higher Interest Rates Relative to Traditional Loans
Since bridge financing is meant to be a short-term loan, you won’t be paying interest for as long as you would be if you took out a traditional loan. To make up for this, some lenders will charge a high interest rate on bridge loans. So, while you may pay less interest in total for a bridge loan, you’ll likely pay interest at a higher rate.
It’s also not uncommon for lenders to charge extra fees on bridge loans. These fees can include origination fees, in addition to closing costs and fees.
Conclusion: Bridge the Gap and Keep Your Business Afloat!
The concept of bridge financing is simple, but that doesn’t mean getting the most from your bridge loan is easy. Knowing when and how to use your bridge loan is just as important as the details of the loan itself. Before deciding on whether to proceed with bridge financing, consider this list of pros and cons, and then closely evaluate your business’s needs.
Editor’s Note: This post was updated for accuracy and comprehensiveness in July 2019.
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.