You may have heard of a bridge loan in real estate, where they typically cover costs between selling one home and buying another. Similarly, bridge loans are available to businesses that need temporary cash while waiting for more long-term capital to fund their next move.
If you think your organization may benefit from this type of loan, you’ll want to understand the details of this option. Discover how a bridge loan works, whether your small business might benefit from one, and best practices for applying.
[Read more: How to Decide Whether You Need a Loan for Your Business]
What are bridge loans, and how do they work?
Bridge loans generally offer short-term funding to cover time-pressing expenses, providing immediate cash flow. They are stopgap solutions that serve while borrowers await more permanent financing.
Commercial or business bridge loans work the same way as bridge loans in real estate, but they instead go toward a variety of pressing business expenses — such as payroll, inventory, or rent — rather than just property.
You can obtain bridge loans from hard money lenders and alternative lenders, and less commonly from banks or credit unions. You’ll have to apply for the loan to see if you qualify, and if you do, you’ll receive funding usually within one week.
However, the process of repaying bridge loans differs from traditional loans. Because they’re such immediate yet short-term solutions, they require quick payoff (terms typically range from a few weeks to up to 12 months). They also often have higher interest rates than other types of financing (the exact APR will vary by lender) and may include some up-front fees.
Types of bridge financing for businesses
There are several different types of bridge financing to meet a business’s short-term needs, including:
- Short-term loans: This type of financing is most commonly associated with bridge loans, which function similarly to their longer-term counterparts. However, they typically deal with lower dollar amounts, have shorter repayment terms, and come with higher interest rates than long-term loans.
- Business line of credit: A business line of credit offers borrowers a set amount of money, which must be paid back with interest. It functions similarly to a company credit card but typically has higher limits based on a business’s revenue.
- Accounts receivable financing: This financing option allows businesses to use future cash flow to cover current costs. The borrower can offer an unpaid invoice to obtain immediate capital from a lender, expecting the loan to be repaid once the invoice is paid in full.
[Read more: How Is Interest Charged on a Small Business Loan?]
When might a small business consider applying for a bridge loan?
Small businesses might apply for bridge loans during “waiting periods” in which they have not yet received long-term funding that would typically cover their expenses.
Take, for example, a business that will close on a financing round in six months. If the business doesn’t have enough capital to fund expenses that come up between those six months—such as purchasing a new building or hiring new employees in anticipation of growth—a bridge loan can help.
Other use cases for a bridge loan include:
- Covering daily operational expenses, including payroll, rent, and utilities.
- Purchasing inventory in bulk, whether to secure better rates or to prepare for a product launch.
- Upgrading equipment to increase the business’s efficiency.
- Keeping the business afloat during slower seasons.
If your plan of refinancing is not secure or has the potential to fall through, you might want to look into more traditional loans, like personal or SBA loans.
Pros and cons of bridge loans
Bridge loans can feel like lifesavers to many business owners. However, making any decisions, you’ll want to consider the pros and cons:
Pros
- They’re quick to fund. If you’re approved for the loan, you have access to that money almost right away, usually within one week. In other words, you won’t have to wait months for the coverage you need right now.
- They’re short-term loans. You typically pay the loan off within one year, meaning it isn’t a looming burden in the back of your mind for years to come. Once you pay it off using the cash influx you expect to receive, you’re done with it.
- You can choose repayment options. As the borrower, you get to decide if you want to pay off the loan before or after your long-term financing is secure. However, this might depend on the lender, so choose one that matches your preferences.
Cons
- They’re difficult to obtain. These loans are more difficult to secure from your average bank. Additionally, you’ll need exceptional credit and equity and a low debt-to-income ratio. Because of the precarious nature of bridge loans, lenders are especially strict about giving them out.
- They’re pricey. Bridge loans have both higher interest and higher transaction rates. If you don’t pay them off in a timely manner, you’ll rack up interest quickly.
- They’re risky. When you take out a bridge loan, you’re counting on an influx of money to help you repay it quickly. If one transaction falls through and you can’t pay back the loan, you’ll land yourself in hot financial water.
It can also help to understand how bridge financing compares to alternative small business funding options, including:
- Term loans: Like bridge loans, term loans require a borrower to repay the lump sum over a specified period. However, term loans come with longer repayment terms and lower interest rates than bridge loans. They can also take longer to fund than a bridge loan.
- Grants: The biggest draw of a grant is that the funds don’t need to be repaid. While there’s no shortage of grants for small businesses, you must carefully review eligibility requirements and application processes.
- SBA loans: Since lenders consider SBA-backed loans to be lower-risk than bridge loans, you can often secure lower interest rates and an extended repayment period. However, if you’re approved for an SBA loan, it can take up to 90 days to receive the funds.
Is a bridge loan right for you?
There’s much to consider before deciding whether to secure a bridge loan. First, you’ll typically have to have great credit, a low debt-to-income ratio, and equity of at least 20%.
If you are approved by multiple lenders, you should review the terms of each before choosing one. Look out for prepayment penalties and hidden fees, and consider the payoff time offered by your potential lenders. Some allow more wiggle room while others demand immediate payment. For instance, you might be required to make monthly payments, or to pay up-front or back-end lump sum interest payments.
You’ll also want to consider the risks at every angle. If your plan of refinancing is not secure or has the potential to fall through, you might want to look into more traditional loans, like personal or SBA loans.
Ultimately, only you know what’s right for your business and what level of risk you’re comfortable assuming. If you think a bridge loan is right for you, research lenders in your area and prepare to apply for a loan.
Tips for applying for a bridge loan
If you think your business could benefit from bridge financing, follow these tips to give your loan application the best chance of success:
- Have a plan for your loan funds. This shows the lender you’re prepared and that you can keep expenditures within budget. Your use of funds plan should break down exactly where the capital will be going and an expected timeline for any projects or initiatives funded by the loan.
- Get your paperwork in order. While specific requirements may vary per lender, you’ll likely need to provide financial statements, collateral documents, and identifying documents like your driver’s license and EIN. Keep this information handy — and accurate — to streamline the application process.
- Carefully review the loan terms. To determine the actual cost of your loan, you’ll also need to factor in the interest you owe and any miscellaneous charges. Additionally, short-term bridge loans tend to require more frequent payments, so ensure you can cover those until you’ve secured more long-term financing.
[Read more: 4 Mistakes to Avoid When Applying for a Small Business Loan]
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