What is a bridge loan?
A bridge loan is a type of short-term finance used to cover an urgent need for funds until other funding is received.
February 2024 | Published by Xero
A bridge loan is a type of bridging finance
Bridging finance is the umbrella term for short-term funding to ‘bridge a gap'. Bridging finance is also known as gap financing and swing loans.
A bridge loan (also called ‘debt bridge financing’) is one kind of bridging finance – it’s a short-term loan to provide you with cash until you can set up a longer-term borrowing option.
The two other main types of bridging finance – equity bridge financing and IPO bridge financing – are not usually used by small businesses.
Why use a bridge loan?
Businesses use bridge loans when they need quick funds to fill a gap until they receive permanent financing or expected payments. A business bridge loan operates similarly to a residential real-estate bridge loan, which gives a homeowner money for their new home while they’re waiting for their old home to sell.
Bridge loans are short-term loans. They’re useful for helping businesses respond to opportunities quickly, and help cash-strapped businesses continue to operate and honour debts to suppliers, until more permanent financing or payments arrive.
Examples of bridge loan uses
Use a bridge loan to:
- cover expenses such as payroll, utilities, rent and inventory costs while waiting for long-term financing, which might come in several payments
- manage seasonal fluctuations in cash flow
- cover temporary cash flow gaps, such as delays in receiving payments from customers or when recovering from a large capital expense
- cover expenses while waiting for an insurance claim to pay out
- respond to time-sensitive opportunities, such as launching a product line or taking advantage of a deal to buy property
For example, you may own a popular restaurant. A restaurant owner is selling their business in another area of the city with excellent demographics. You’re ready to expand but you’ll need financing and getting approval will require several months. The owner wants to sell quickly, so you get a bridge loan so you can buy the restaurant and repay the loan once your long-term financing is approved.
Features of bridge loans
Bridge loans have several characteristics:
Short term: Bridge loans are usually for 12 months or less.
Rapid approval and funding processes: Because bridge loans are a source of quick cash, they have a rapid approval and funding process.
High interest rates: Lenders see bridge loans as being riskier than traditional loans, and they only have a short time in which to profit from them.
Varied repayment terms: Bridge loans can have closed or open repayment terms. Closed loans have a specific repayment date, such as when you receive your permanent finance or complete and receive payment for a specific project. Open loans have no clear exit strategy but still have to be repaid within the term.
Closed loans tend to be easier to obtain and have lower interest rates because the lender knows how you’ll pay back a closed loan.
Secured by collateral: Bridge loans are secured by collateral (such as property or inventory) to make the risk more acceptable to lenders.
Bridge loans: for and against
If used sensibly, bridge loans have several advantages:
- Speed: They can be arranged much quicker than a normal term loan; some lenders can fund bridge loans in less than a week
- Higher limits than other forms of lending: You can borrow more than through a credit card or credit line because the loan is secured by an asset
- Flexible structure: Bridge loans may be available with open or closed terms, fixed or variable interest rates, interest-only monthly payments or with capitalised fees and interest
But bridge loans also have disadvantages:
- High interest rates: In some cases, bridge loan lenders calculate interest monthly rather than annually, pushing the repayments even higher, so if you’re already experiencing cash flow issues, taking out these loans could be a slippery slope
- Fees: There may be fees to set up the loans and for an early exit
- Risk: You could lose your collateral if your permanent funding falls through and you can’t repay the bridge loan
How to get a bridge loan
Before applying for a bridge loan, think about: how long you’ll need the funds, how you’ll use the funds, and how you’ll repay the loan.
You’ll also need to meet the lender’s criteria. In most cases, you’ll need:
- a decent credit history
- collateral, such as inventory, equipment or property
- proof you can make repayments
- an exit plan, such as proof of an incoming lump sum from a customer payment or a permanent type of finance
To learn more about getting approved for bridge and traditional loans, check out our guide How to get a business loan.
Talk to your bank
If you need a bridge loan, talk to your bank first. You’ve already developed a relationship, and your own bank knows your business best. Not all banks offer bridge loans, however, and there are financial providers who specialise in bridge loans. Make sure you deal with reputable providers.
Your accountant can also advise you and help provide the financial information about your business for the application. Using small business accounting software, like Xero, can make this process faster and easier.
Disclaimer
Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the content provided.
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