Bridge Loans 101: How They Can Help Your Small Business
November 11th, 2019 by Advance Point Capital
As any small business owner knows, it isn’t easy to turn your venture into a success. One in twelve businesses is forced to close each year, with a third of small business owners citing a lack of capital as their top challenge. For a quick and easy short-term financing solution, many business owners turn to bridge loans for help during tough times.
What is a Bridge Loan?
A bridge loan is a type of funding that many small businesses use to satisfy an immediate need for cash. They’re typically quicker and easier to secure than traditional long-term loans, but also tend to be more expensive.
In general, businesses don’t use bridge loans to cover long-term expenses. Instead, this type of financing “bridges” the gap between an immediate need for cash and a more permanent solution. For example, a business may expect to pay off a bridge loan with future revenue or may refinance with a long-term loan instead.
Unlike traditional loans, bridge loans tend to have a short repayment period. Many offer terms ranging from just a couple of months to five years. This often means that lenders expect more frequent payments, sometimes as often as daily or weekly.
A Brief Overview of Bridge Loans
- Short-term financing
- Fast, convenient funding
- Quicker and easier than traditional loans
- A versatile cash flow solution
- Short repayment period
- Flexible payment options
The Most Common Uses for Bridge Loans
Bridge loans are versatile enough to be used across a wide variety of industries, from service to manufacturing. They can be used to address just about any short-term cash flow problem that may affect the future success of a business. Here, we go over some of the most common cases where bridge financing can come in use.
Buying Real Estate
Buying commercial real estate can be a challenge, especially when different parties are competing for a prime spot. Businesses need to act quickly if they’re going to land a desirable real estate deal. However, many small businesses don’t have the capital lying around to afford a property upfront. What’s more, it can be difficult to gain approval for a traditional bank loan.
Fortunately, bridge loans give businesses the option to get their hands on cash in as little as a single day. This allows the company to secure a property that will boost its future revenue, thus paying for itself. Often, a business will refinance the bridge loan after landing the real estate deal with more economical long-term financing.
Fixing Up a Property
Sometimes, a business isn’t able to secure a long-term mortgage because a commercial property doesn’t meet the strict requirements of potential lenders. However, it can be expensive to bring a building up to code.
Small businesses can take out a bridge loan if they need to fix up a property before applying for long-term financing. Once they’ve made renovations, they can refinance the bridge loan with a traditional, long-term mortgage.
Keeping Businesses Afloat
Many small businesses need a large investor or acquirer to survive in today’s corporate atmosphere. However, it can take months or even years for a company to attract the attention of a financier.
To avoid cash flow issues while looking for an investor, small businesses can take out a bridge loan. Doing this helps to cover costs such as rent, utilities, wages, and more. Eventually, it will be paid back by investor funds.
Starting a Business
Bridge loans are ideal for those who are starting a new business and don’t have a significant source of revenue yet. It can help to cover their costs as they become established and create a customer base. Once the business begins to net money, the owner can pay off the bridge loan.
Bridge loans can be especially helpful for those entering manufacturing. Companies typically don’t get paid until after they’ve shipped a product, leaving them responsible for initial costs. A bridge loan can help to cover expenses such as materials and labor, and it can be repaid upon delivery of the goods.
Why Use Bridge Loans?
Your small business can benefit from taking out a bridge loan to solve short-term cash flow problems. You can use funds to address time-sensitive issues such as buying real estate, covering business expenses, or padding cash reserves.
In general, it’s much easier to gain approval for a bridge loan than long-term financing. Most alternative lenders have far more lenient qualifications for businesses looking to take out a loan. Applications are also streamlined, and some are even available to fill out online in the comfort of your own home.
Often, you can get same-day approval for bridge loans. With some financing options, you can have extra cash in hand immediately. In contrast, it can take days or even weeks to process a traditional long-term loan or mortgage.
The Different Types of Bridge Loans
When it comes to bridge loans, there’s no “one-size-fits-all” solution. Rather, there are a variety of financing options to cater to the various needs of different business owners. Here, we go over the four main types of bridge loans that small business owners use to keep the cash flowing.
Short-term loans are essentially identical to long-term financing options but tend to deal with smaller amounts of cash and offer shorter repayment periods. For the most part, short-term loans offer repayment schedules of no longer than eighteen months.
Short-term loans are also much easier to secure than their long-term counterparts. In general, small businesses can gain approval for a short-term loan in just one day. However, the interest rates tend to be significantly higher than long-term rates. Most short-term loans come with interest rates of at least 10% or higher.
- Businesses don’t have to commit to a long-term loan
- There’s little paperwork to deal with
- The approval process is quick
- Higher interest rates than other types of loans
- May require daily or weekly repayment installations
Business Line of Credit
A business line of credit works much like a company credit card. You have a set amount of cash that’s at your disposal, but you have to pay it back with interest. You also can’t exceed your upper limit. In general, limits are much higher than those on credit cards.
Unlike other types of loans, a business line of credit only requires that you pay interest on the funds that you take out. However, most lenders require that you take out a larger initial loan than other options. Interest rates also tend to be relatively high at 8% or more.
- A flexible choice for multiple business types
- Helps businesses build good credit
- Pay no interest on unused funds
- Businesses may have to offer collateral as insurance
- Interest rates and other fees can be pricey
- Paperwork can be complicated
Accounts Receivable Financing
For businesses that don’t get paid until the end of a job, such as construction, service, and more, accounts receivable financing options allow them to use future revenue for current cash flow problems. Accounts receivable financing can also come in handy for manufacturing businesses.
With this type of bridge loan, you can offer up an unpaid invoice to get cash from a lender. Often, you have to pay a weekly fee until you’re able to cover the cost of the loan in full, making this a pricey option despite low interest rates.
This type of financing can also be somewhat risky, as it assumes that you’ll be receiving a payment from your client or customer in full. Additionally, if a client has bad credit, it may mean that you’ll be disqualified from taking out a loan.
- Immediate or near-immediate funding
- Easy application and approval process
- Doesn’t require collateral
- Approval depends on client credit
- High-risk option
- May be recurring weekly fees
Merchant Cash Advance
A merchant cash advance is perhaps the most straightforward type of short-term bridge financing. An alternative lender simply gives you a predetermined amount of money upfront, and you’re able to spend this as you see fit.
In addition to repaying the cash with interest, however, you also have to pay the lender with a small percentage of your sales. This can make a merchant cash advance a significantly more expensive option than other types of bridge loans, especially for businesses that turn a healthy profit.
- Few qualification requirements to meet
- Most lenders don’t ask for collateral
- May be expensive due to interest or other fees
- Many advances require daily repayment
What to Look for in a Bridge Loan
As a small business owner, it can be difficult to decide which type of bridge loan is right for you. With so many alternative lenders to choose from, it can be easy to find yourself feeling overwhelmed. It’s important to know what key features you should look for in any bridge loan, regardless of the type.
Many business owners’ first consideration when looking at short-term loans is interest. Often, short-term loans have higher rates than long-term loans. Not only are people willing to pay for convenience, but lenders must take into account risk when agreeing to loan out cash.
You should look for a bridge loan that offers an interest rate that you can handle. Take the time to figure out exactly how much extra you’ll be spending in addition to the initial advance over the course of the payment period. If this amount exceeds what you expect to earn thanks to the loan, it may be better to look elsewhere.
It’s also a good idea to look into any extra fees that a lender may charge, such as a percentage of your sales or certain penalties. Many business owners end up paying off their short-term loans earlier than expected, and so it’s a good idea to look for bridge loans that don’t charge prepayment penalties.
You should also consider how long it might take you to earn the funds to pay off a short-term loan. If you can’t afford regular repayments, you may want to look for something with a longer payment period. Shorter-term bridge loans tend to require more frequent payments. Some agreements even stipulate that the borrower has to make daily payments.
How to Refinance a Bridge Loan
Not all business owners plan to pay a bridge loan off in the given period. Often, they plan to switch over to a long-term financing option instead. Long-term loans tend to have more favorable terms, such as lower interest rates and fewer fees.
The purpose of a bridge loan is primarily to get your hands on some quick cash. Traditional loans can take days or even weeks to process, and they often have strict qualification credentials for small business owners.
Once you’ve used the funds from a bridge loan to fix your cash flow situation, however, it can be more economical to spend time switching over to a long-term loan instead. This is especially true of business owners who don’t expect an influx of extra cash anytime soon.
You can do so by refinancing your bridge loan. If you meet the qualifications, you can turn to a lender such as a bank to work out a more favorable long-term solution to paying off what you’ve borrowed.
If you can’t gain approval with major lenders, there’s no need to worry. You can always consider a small business loan, or SBA loan, as an alternative option. This type of financing is backed by the government, making it a low-risk option for lenders. This allows them to give money to small business owners who don’t qualify for traditional loans.
SBA loans are often larger than bridge loans, sometimes reaching up to $5 million. They also have much longer repayment terms, often ranging up to 25 years. Because they’re low-risk, lenders are able to charge lower interest rates than they might otherwise.
The Bottom Line on Bridge Loans
Bridge loans can be an invaluable tool for small business owners, helping to address cash flow emergencies before they snowball into bigger issues. Securing a bridge loan is fast, easy, and offers a temporary fix for just about any financial mishap. While they may be more expensive than traditional financing, the initial investment needed to take out a bridge loan can help a small business to ensure a successful future.