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How to Use Bridge Loans for Small Businesses
Commercial bridge loans, also known as business bridge loans, are a type of short-term business loan to use in time-sensitive situations where you don’t have cash on hand and you don’t have time to wait for the full funding with a longer term loan to be approved. They help you make a purchase today while you wait through the approval process at a bank, credit union, or alternative lender, so you can meet a deadline or prove that you have financing for a large purchase like real-estate, equipment and machinery, or a competitor acquisition.
Here’s how to use commercial bridge loans for your small business, what lenders offer them, and what other options you have. First we’ll start with how bridge loans work.
How Bridge Loans for Small Businesses Work
Business bridge loans work by providing fast financing to a company for time-sensitive situations so the business can make a purchase or put a deposit in while waiting for other financing to close. They’re similar to other small business loans in that you apply, provide business plans, financials, credit history, and other documents, then get funded when approved.
They’re different because you get them when you’re expecting funding from another loan for the same purchase you’re using the bridge loan for, or when you’re using the bridge loan to get something ready for sale.
Commercial bridge loans offer shorter payback periods compared to longer term-loans and usually have a higher interest rate. But because you pay them off once your other financing closes the total amount of interest can be worth it for the fast funding and to avoid losing a deal or property you want to buy.
Collateral is one of the most important requirements for bridge loans given the quick approval timeline because it lowers the risk for the lender without them needing to fully vet a business plan or finances behind a personal guarantee. Because you may not own the asset during the time gap between the business bridge loan and final amount of financing, you will likely need to use other owned business assets like vehicles, property, and even stocks.
How much you’re able to borrow comes down to the Loan-To-Value (LTV) or Loan-To-Cost (LTC) ratios:
- The LTV ratio measures the loan amount versus the value of the collateral where LTV = Loan Amount / Collateral Value.
- If you’re buying a $1,000,000 building and the bank will loan a maximum 80% LTV, then you can borrow up to $800,000.
- LTC is similar but uses the total purchase cost instead of value. You calculate the max loan amount of $187,500 for a $250,000 truck with a 75% LTC ratio as:
- 75% = $250,000 * $187,000.
If a business bridge loan is right for your situation, it’s time to find a lender that offers them, like us.
Types of Lenders Offering Bridge Loans
Most types of lenders offering commercial bridge loans fall into one of two categories:
- Commercial banks and credit unions
- Alternative and online lenders (and aggregators that connect with multiple direct lenders)
Banks and Credit Unions
Banks and credit unions are a great choice when you have an existing relationship because it makes approval smoother since they know your credit history. That will give them confidence you won’t default and can help keep interest rates low, not to mention speeds up the process which is normally a lot slower than an alternative and online lender.
Here are the overall pros and cons of using business bridge loans from banks or credit unions for your small business:
Pros:
- It is sometimes possible to get lower interest rates compared to alternative lenders.
- The chance of a funding or wire glitch is reduced when you already have an account set up at your bank or credit union.
- A smoother application and approval process when they already have many of your financials and credit history.
Cons:
- Longer approval times compared to online lenders.
- Stricter approval and collateral criteria if you don’t have great credit.
- If they’re unfamiliar with your industry or niche, red tape could get in the way and label you as high-risk and you get declined.
- You may be required to go to a physical location to apply.
Direct Online Lenders
Online lenders like us offer business bridge loans directly where you apply through a form and submit your information.
Applying directly or through an online marketplace is a smooth and simple process that eliminates the need for you to show up to a physical location or a branch which may be required by a large bank or credit union. Since everything is done online, commercial bridge loans tend to be approved faster than traditional lenders.
Here are the pros and cons of bridge loans from online lenders:
Pros:
- Fast application, approval, and release of funds compared to traditional lenders.
- Options available for less-than-great credit.
Cons:
- Higher interest rates versus regular banks or credit unions.
- There may be lower amounts of financing available compared to a large bank.
When Small Businesses Should Use Commercial Bridge Loans
Business bridge loans are a great option to expand your business or buy another business that has a deadline for offers, for purchasing a building before a long-term mortgage closes escrow, and as a way to cover a delay in one of your customers paying a large invoice.
Expanding Your Business
Bridge loans help you expand your business and take advantage of timely opportunities before your competitors do. The fast approval and release of funds lets you to do things without delay, including:
- Purchasing new property through a foreclosure auction that requires cash in hand.
- Expanding through acquiring a competitor or a complimentary business before other offers get accepted.
- Get bids in on bulk raw materials, equipment, and other big purchases that require fast financing to expand capacity and output if your company needs to increase as you expand your operations.
Using bridge loans to expand your business gets you generating cash flow immediately and makes sure you don’t miss out on opportunities that give you a competitive advantage.
Bridge Loans for Real Estate Investments
A business bridge loan helps you buy real estate before escrow closes on a long-term mortgage so you can move in right away and begin operating. By having the deposit ready, the seller knows you have funding and won’t back out of the deal. You’re also able to use bridge loans to fix up property you own and plan on selling, and you then pay off the bridge with proceeds from the sale.
Covering Delays in Accounts Receivable
Bridge loans can fill a cash flow gap when customers are late to pay on accounts receivable. This could be due to a single large customer withholding payment or because of an unusual amount of chargebacks from credit card processors. Another reason could be for damage and cleanup costs you’re stuck with after an emergency, fire, or natural disaster while you wait on insurance reimbursements.
Purchasing Expensive Equipment or Winning Auctions
If you need to replace or purchase a piece of expensive equipment and there is a limited supply with multiple buyers, or it is in an auction with a buy it now price, the commercial bridge loan can get you the deposit to secure the deal while you wait for the rest of the financing to clear.
Working Capital Needs
Bridge loans work for working capital when you know you’ll have the money coming right back in like when hiring seasonal staff for increasing holiday traffic, paying a high tax bill because your business is growing faster than your estimated payments, or for rent and utilities at a new location right before opening. You’ll make the money back fast and be able to clear the cost of the bridge loan, so it helps you “bridge” the gap in financing.
When to Avoid Bridge Loans
Because bridge loans are meant to “bridge” the gap between a purchase today and getting a long-term loan approved or equity financing closed later, other types of short-term business loans are better for expenses like these:
- Purchasing inventory
- Advertising
- Hiring temporary labor
- Rent
- Utilities
It’s best to avoid bridge loans when you don’t have a good idea when the other financing or cash from sales will come through as the higher interest rate and shorter payback period of a bridge loan will eat into your profits.
Other types of small business loans are better options for specific situations including:
- Traditional working capital loans are better when you need to cover operating costs but don’t know when the money is coming back to the business. Advertising is an example since you don’t know when the customers will come in, and in an SaaS company it could take a year for the customers to convert into paying users.
- Inventory financing is the go-to option when you’re buying inventory because it serves as collateral for the loan so you don’t have to include other business assets to help keep interest rates low.
- Revenue-based financing where you make payments based on a percentage of sales can be a good alternative to commercial bridge loans when you have uncertain cash flows since you don’t have to pay a fixed amount each month.
- Invoice factoring is an alternative to commercial bridge loans when you have accounts receivables but need cash now because you can sell the invoices to a third party for a discount and get cash in hand.
Using a bridge loan for your small business helps you make purchases that you need right now but that you can’t pay for out of cash or have enough time to get money from another source of funds. Find out how our bridge loans will help expand your business, buy new real estate, or cover cash flow gaps from late accounts receivable or operating expenses you need to meet the demands of your growing business.
We do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.
