Wednesday 7 April 2021

Business.com

Business.com


How a Bridge Loan Can Hold Your Business Over

Posted: 06 Apr 2021 06:00 AM PDT

A bridge loan is a form of short-term financing that is designed to help a company meet its obligations until it secures a long-term business loan. This type of business loan is commonly used in commercial real estate and other transactions where timing is key and businesses need to secure funds quickly in order to take advantage of an opportunity.

When a business takes out a bridge loan, it uses the proceeds to purchase or improve assets, or to finance its own operations. Then, once it secures long-term financing, it uses the funds from the new long-term loan to pay off the bridge. Businesses use bridge loans (which often carry interest rates several points higher than conventional long-term financing) to fill short-term funding gaps. These include asset purchases, such as real estate, equipment, and inventory.

5 common uses for bridge loans

Use Why a bridge loan is advantageous
Real estate purchase You can get financing to acquire property with abbreviated underwriting.
Real estate improvement You can expand or renovate to take advantage of opportunities to expand your offerings or modernize facilities.
Equipment purchase You can buy equipment at auction or secondhand.
Purchase of foreclosed asset You can buy deeply discounted assets with financing secured by outside collateral.
Seasonal inventory purchase You can purchase or restock inventory without using a merchant cash advance.

 

These aren't the only uses for bridge loans, but they're the most common. Bridge loans are typically used in cases where businesses have short-term funding needs or an opportunity to purchase assets at steep discounts. Using bridge loans, your business can take advantage of these opportunities without being slowed down by underwriting, tiding you over until you can secure long-term financing.

Editor's note: Need a loan for your business? Fill out the below questionnaire to have our vendor partners contact you about your needs.

 

1. Buying real estate

Financing commercial real estate can be a complicated, time-intensive process. Lenders have to review your company financials, plus property-specific issues like inspections and appraisals. The process can take even longer than usual if you have to do any retrofitting to the property (especially if permits are required) or if issues arise with your personal finances. With so much to do, underwriting a conventional term loan for commercial property can easily take longer than the 30 to 45 days allowed in most purchase agreements.

You don't want to miss out on an opportunity to close on a key piece of property – especially if you're securing it for an attractive price. You can use a bridge loan to close on the property, and then pay off the bridge loan balance with the proceeds of a new loan once you lock in long-term financing. This way, you don't have to miss out on the closing deadline, lose your deposit, or pass up a great deal.

2. Improving real estate

Bridge loans can also be a great option for expanding or renovating property. Many industrial, manufacturing and even retail companies occasionally need to expand, renovate, or otherwise improve property in order to expand production or develop new offerings. But getting a conventional term loan to start work can be difficult, especially if the property is already fully collateralized.

When you encounter opportunities to expand or renovate your facilities – to add value to your property or refine your product lines – you can't let them pass you by just because you can't get a conventional term loan right then. In this instance, a bridge loan can help you start the work without waiting on a long, drawn-out underwriting process – and then you can refinance your property at a higher value once work is complete (or nearly complete).

3. Buying equipment

Your business might also get opportunities to purchase equipment secondhand (at an auction, for example) at a deep discount – but these opportunities never last long. Moreover, because you won't always be certain what model you'll be buying or what its value will be, it can be hard to obtain conventional financing for this type of purchase beforehand.

In these cases, you might be able to use a bridge loan collateralized by other business assets to finance the purchase of new equipment. You can pay off the loan or refinance later with a longer-term loan secured by the specific piece of equipment you purchase.

4. Acquiring a foreclosed asset

If you've ever been to a sheriff's auction, you know that sometimes you can buy some great assets for just pennies on the dollar, but you don't always know what you'll find. This lack of specifics makes it basically impossible to arrange conventional financing before you bid at an auction.

Even if you do know what you plan to buy, many lenders won't lend against assets being purchased out of foreclosure. Many lenders require you to pay for those assets with cash or through loans secured by other assets.

In this case, you can get a bridge loan secured by separate collateral and use those funds to make an offer or bid on an asset. Then, you can make interest-only payments until you can refinance with a conventional loan.

5. Meeting seasonal inventory needs

Many retailers use lines of credit to purchase inventory. Unfortunately, some businesses don't have access to that type of funding or have already maxed out their line. In this event, a merchant cash advance (which is usually very costly) may be the only other way to buy much-needed inventory – to restock after a sudden surge in sales or prepare for an influx of business.

Rather than using a cash advance, you can use bridge loans to buy inventory, then refinance with a conventional business loan or pay off the bridge with the proceeds from your sales.

Bridge loans vs. conventional bank term loan

Here's a quick comparison between bridge loans and conventional bank term loans.

  • Higher interest rates: Bridge loans' rates often start at 8% to 10%.
  • Faster underwriting: Bridge loans can be secured in 30 to 45 days; conventional loans can take longer, especially if you already have outstanding loans.
  • Lower LTV: Bridge loans' loan-to-value ratios typically max out around 70%.
  • Shorter loan term: Six to 12 months is often the limit for bridge loans, as opposed to five or 10 years for conventional term loans (with amortization schedules that can go up to 20 or 25 years).
  • Interest only: Bridge loans are interest-only loans; conventional loan payments include both principal and interest.
  • Separate collateral: Conventional financing is usually secured by the specific asset being purchased or improved, but bridge loans may be secured by separate assets.
  • Higher qualification requirements: Because bridge loans are faster and a greater risk to the lender (if the borrower can't refinance the loan), they often have strict criteria for the business's creditworthiness.

When most people take out a bridge loan, they get it as an alternative to a conventional bank term loan. What typically happens is that a business owner plans to use a conventional term loan to finance some acquisition or project, only to run into a problem in underwriting, at which point they find that they'll need to find a faster short-term funding alternative or abandon their plans.

A bridge loan allows the business owner to still pursue their plans, at terms that aren't wholly inferior to those of conventional bank loans. For example, not only are bridge loans faster and easier to get than conventional bank loans, but the payments are often interest only, which can reduce your holding cost until you can refinance.

However, there are downsides to bridge loans as well. For one thing, they typically don't allow you to borrow as much against underlying assets as conventional loans do. In fact, LTV ratios are typically capped at about 70%.

Bridge loans also usually carry higher interest rates than conventional financing (even though payments are often lower because they're interest only). Loans also only last six to 12 months and may require collateral outside the assets being purchased.

A bridge loan is a short-term financing option designed to help businesses bridge any gaps in their funding requirements. These loans can help your business secure funding quickly to take advantage of opportunities, and then pay off the loan once you secure longer-term, fixed-rate financing. While bridge loans are often faster and easier to get, they may involve higher interest rates and lower LTV ratios. Nevertheless, they can be extremely beneficial, especially in commercial real estate transactions or secondhand asset purchases at steep discounts.

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