Bridging finance is a type of short-term debt finance to ‘bridge’ the gap between payments falling due and funds becoming available. Bridging loans are usually for a term of less than 12 months and can be used by businesses to cover their funding requirements. Learn more about the basics of bridging finance for small businesses below and see if it could support your capital funding requirements.
In this article, we will be covering:
- What is bridge financing?
- How do bridging loans work?
- Why use a bridging loan as a small business?
- What are the disadvantages of bridge financing?
- What is an equity bridge facility?
- Interest rates: how much would bridging finance cost?
- What would your interest repayment options be?
- What types of security should you use?
What is bridge financing?
Bridge financing is a form of short-term loan used to tide a company over until it can raise money by other means. For example, a company may have expenses to pay before it can raise money through private equity funding, issue shares or float on a stock market. The company obtains a bridge loan to meet its funding requirements while it waits to complete a private equity 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.
How do bridging loans work?
A bridging loan is designed to be used in only limited circumstances and normally only in anticipation of a company receiving more long-term funding. Bridging facilities tend to be revolving credit facilities provided on a committed basis by a bank. This means that the lender is committed to providing the funds if requested by the borrower.
For more information on revolving credit facilities please see Corporate loans: the basics.
Bridging facilities (or ‘standby facilities’) are common where a borrower is planning to raise money on a capital market by issuing medium term loan notes or may be used to temporarily support a transaction for which financing has been delayed. The bridging loan provides guaranteed funding if raising money through the loan notes falls through or until other financing can be obtained.
Why use a bridging loan as a small business?
A small business may wish to obtain a bridging loan to provide short-term finance before it is able to obtain a longer-term loan. For example, a small company may require bridge financing to cover a real estate project in the very early stages of development. A bridging loan can provide much needed capital until a longer term loan is obtained.
Larger companies may wish to obtain bridge financing in order to support a debt offering on a capital market. For example, a large company will generally wish to obtain a ‘swingline’ facility as part of a larger revolving credit facility during the process of issuing commercial paper.
Companies should beware using bridging loans for longer term funding purposes. Bridging loans are only designed to meet a gap in funding and are generally more expensive than longer term options.
What are the disadvantages of bridge financing?
Bridging loans only provide a short-term solution for companies. They are only designed to cover short-term funding requirements and should not be seen as an alternative to more mainstream lending.
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 is 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.
Interest rates: how much would bridging finance cost?
Generally, banks will charge an arrangement fee of around 1-2% of the amount borrowed as an arrangement fee on bridging loans. In addition, companies can expect to pay monthly interest fees of around 1% and may be required to pay a further 1% as an exit fee.
What would your interest repayment options be?
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. With retained interest a borrower must pay 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 with retained interest than the other options.
Rolled up interest is added to a loan each month and the interest is 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 types of security should you use?
When applying for a bridging loan, most lenders will consider any form of real estate as acceptable security. This may include:
However, other forms of security may be acceptable, depending on the lender.
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.