Bridging or bridge loans are a particular type of finance and are used by businesses to ‘bridge’ a gap between their current funding needs and available cash. They’re often used by companies who anticipate a need for long-term debt finance, but don’t yet have that funding in place. The bridge loan is used by the borrower to fill that gap.
In this article, we explore the basics of bridging finance, and show you how it could support your capital funding requirements.
In this article, we will be covering:
- What's a bridging loan?
- Why would a small business need a bridging loan?
- What are the main terms of bridging loans?
- What are the advantages of bridging loans?
- What are the disadvantages of bridging loans?
- What's an equity bridge facility?
- What are the typical fees and interest rates on a bridging loan?
- What are interest repayment options on a bridging loan?
- What can I use as security for a bridging loan?
What's a bridging loan?
Bridge financing is a form of short-term loan used to tide a company over until it can raise money by other means. They’re intended to be temporary in nature, with a maturity of 12 months or less.
For example, your business may have expenses to pay before you can raise money through private equity funding, issue shares or float on a stock market via an Initial Public Offering. In order to pay these costs, you may get a bridge loan while you wait to complete a funding round. Once the funding is complete, the company pays the loan back together with interest to the lender.
Bridge loans may also be referred to as ‘caveat loans’, ‘standby facilities’ or ‘swing loans’. In the UK, the term ‘bridging loan’ is more commonly used.
As bridging loans tend to be higher risk than longer term finance, they tend to attract higher interest rates, so should only be used where you are confident that you will achieve your longer-term finance requirements. They usually take the form of revolving credit facilities provided on a committed basis by a bank. This means that the lender is committed to providing the funds if you request it.
For more information on revolving credit facilities please see Corporate loans: the basics.
Why would a small business need a bridging loan?
Small businesses often need bridging loans where they are awaiting long-term funding. These loans enable the borrower to ‘hedge’ against delays or other issues that may cause that longer term loan to fall through.
Bridging loans can also be used by businesses wanting to purchase property, and who need time to arrange funds. A bridging loan can be used to secure the sale. In addition, occasionally businesses who are in an otherwise strong financial position can use a bridging loan to fund short-term cash flow issues.
What are the main terms of bridging loans?
Bridging loans are made between a borrower and a lender. They tend to have a short maturity date from a few months to year, although this might be extended if you fail to secure long-term finance.
Your bank will typically issue a commitment letter in which they engage to offer you finance, as well as a term sheet outlining the terms on which they will lend.
Expect to pay fees as well as interest on your bridging loan. The level of fees and charges are typically higher than ‘normal’ corporate loans since the lender will want to incentivise you to repay the loan as quickly as possible.
Your bank will also expect to secure the bridging loan with collateral, such as property.
If you’re considering a bridging loan, make sure you can get your hands on the finance quickly enough. Traditional banks may be slower than alternative lenders, so shop around.
In addition, you may want to negotiate a prepayment incentive should you be able to pay the loan off early. That way, you’ll save interest should your long-term finance be available more quickly than you envisaged.
What are the advantages of bridging loans?
The advantage of bridging loans is that they enable borrowers to get hold of cash quickly, either to take advantage of an opportunity such as a property purchase, or to tide them over until longer-term finance is arranged.
What are the disadvantages of bridging loans?
Bridging loans are only a short-term solution to funding issues and are not a viable alternative to mainstream lending as both fees and interest rates are high.
Due to the additional risk of bridge loans, banks will generally charge a higher rate of interest on a bridging facility than on longer-term forms of finance. The terms of a bridging loan tend to be more restrictive and place more obligations on a borrower than longer-term loans.
What's an equity bridge facility?
An equity bridge facility is a loan provided to private equity funds to finance the difference between contributions coming from the private equity fund and those due from investor capital contributions to fund an acquisition. In other words, the bridge facility bridges the gap between a fund’s own contributions and those it expects to receive from investors. The money advanced to the fund will then be reimbursed by the limited partners of the fund when they make their capital contributions.
In a private equity bridge facility, the fund’s obligations will generally be secured by assigning the rights of the general partner over each limited partner’s contribution. Security will also normally be granted over the bank account into which limited partners will pay their capital contributions.
What are the typical fees and interest rates on a bridging loan?
Generally, banks will charge an arrangement fee of around 1-2% of the amount borrowed as an arrangement fee on bridging loans and may be required to pay a further 1% as an exit fee. Interest rates can be as high as 2% per month.
What are interest repayment options on a bridging loan?
Bridging loan interest repayments are normally retained, rolled-up or monthly.
Retained interest is where the lender ‘retains’ the interest for the duration of the loan. The borrower pays the full amount of interest at the end of the loan in a single lump sum. For this reason, the rate of interest tends to be higher than other options.
Rolled up interest is added to the loan each month and compounded with the loan. This means that interest is paid upon the original loan plus any previous interest. Rolled up interest tends to be less than retained interest, but more than monthly repayments.
With monthly repayments, interest repayments are set and paid monthly. Monthly interest repayments tend to incur the lowest rate of interest when compared to the other options.
What can I use as security for a bridging loan?
When applying for a bridging loan, most lenders will consider any form of property as acceptable security, including land, buildings and machinery.
If you’re considering bridging finance as an option for your business, make sure that it’s simply a stop gap that will temporarily support you until you gain access to longer term funding options. Be mindful of any hidden charges and if in doubt consult our banking and finance solicitors for further advice. Get in touch on 0800 689 1700, email us at enquiries@harperjames.co.uk, or fill out the short form below with your enquiry.
