Last Updated on November 6, 2020 by Kimberly Crawford
When you or your business need a short-term cash infusion, you have options. Bridge financing offers a way for both commercial entities and private individuals to handle a shortage of working capital. Read on to learn more about this specialized form money lending.
How Bridge Financing Works
Bridge financing gets its name from the fact that it acts as a bridge between when your money runs out and when you next expect to receive cash. Think of it as a way to financially get from here to there.
California hard money lenders commonly extend bridge financing to organizations that have negative working capital, i.e., its ratio of current assets to current liabilities has fallen under 1. The goal is to quickly restore the company to a state of positive working capital so it can resume day-to-day operations and invest in its future.
Private individuals can utilize bridge financing as well. For example, residential bridge loan lenders provide funds for both homeowners and real estate investors to take out money against their current residential property so they can buy a new one. Residential bridge loans can work in the opposite direction, too. Someone looking to buy a new home can borrow money against that property.
The 3 Types of Bridge Financing
Bridge financing is sorted into three categories. Which route you pursue depends on a variety of factors. For companies in particular, the choice of financing largely depends on how dire its present financial situation is.
Debt Bridge Financing
This type of financing is most commonly handled via bridge loan, which is a short-term loan with a high interest rate. Both corporate entities and private individuals may pursue bridge loans. For example, house flippers often pursue private money loans California in order to fund their projects.
Equity Bridge Financing
A company might choose this option if it wants to avoid a high interest rate and can secure the backing of a venture capitalist or firm. The VC typically agrees to extend the loan in exchange for equity ownership, the idea being that the initial investment will pay off considerably when the company succeeds.
IPO Bridge Financing
As its name suggests, this type of financing is reserved for companies that are about to make their initial public offering. The company takes out a short-term loan to cover the costs of the IPO and then repays it immediately afterward.
Benefits of Bridge Financing
The following are the chief most benefits you may get in case you become a part of it.
- It helps you get through the tough time before you gain access to the capital when your business is in a tight position. Running out of cash to meet the upfront expenses is highly troublesome even for a healthy business. Cash flow problem has been found to be the second most common reason for a startup’s failure. Bridge financing gives you an easy access to cash and solve your financial crises before you get long term access to your awaited cash.
- Since private lenders offer such loans, approval time is much shorter as compared to the other bank-issued loans. You never have to drag your feet to various banks to get your loan application approved.
- It offers you the fastest speed of funding. You can receive a bridge loan within hours or a few days at the maximum if you have once got it approved. You will verify that this is some of the fastest business loans when you compare this loan to other types of funding.
- Bridge funding options are short-term. There is no fear of getting weighed down by promising to retire a loan that will require years to pay off. These loans usually last from 3 to 18 months.
- A bridge loan never requires you to pay any prepayment penalties if you have got in a position to pay it back earlier than the expected time. Many other small business funding solutions never offer such a great facility.
- Bridge loans comprise up to 80% of the value of the borrower’s current or proposed property. So, this is a totally wrong concept that bridge loans contain only the 50% of the current value of your property.
- You are not restricted to use bridge loans for your business alone. You may also use them for your personal purposes. For instance, you may retire some other loan you might have taken previously.
The risks involved in bridge loans
You must keep in mind the following major risks while planning to avail a bridge loan.
- The worst risk involved in bridge funding is the highest interest rate. In case you are unable to pay off one installment, the interest will accumulate much faster than you expect.
- You need to invest the bridge loan in a project that must worth it. Otherwise, you will not be able to pay back the amount of interest smoothly if you don’t find a suitable way to invest it.
- You have to make an injection of capital shortly after you get a bridge loan. This is because any delay will pile up the interest and you will be likely to collapse financially.
- Some lenders can charge extra fees on bridge loans. These may also include origination fees, closing costs and fees, etc.
No matter which type of bridge financing you or your organization pursues, expect a variety of terms and conditions to be part of the loan process. These are typically employed to protect the person, firm or institution extending the loan. For example, it’s common for the lender to issue a penalty — such as a significant bump to the established interest rate — if a loan isn’t repaid by the agreed-upon date.
As with any type of support, there are pros and cons to bridge financing. That said, if you’re comfortable with a high interest rate or similar risk and feel comfortable that your financial situation is soon to improve, consider bridge financing to help you make your next move.