Small businesses, whether established entities or recent startups, typically need growth capital or other types of funding to aid their development. Many existing businesses have accessed small business loans, lines of credit and business credit cards, while a startup might have received capital funding from investors and other sources. In the event of an unexpected cash crunch, these owners may need to seek the alternate form of small business funding known as a bridge loan.
Who can Benefit From a Bridge Loan?
An established business may be in the middle of refinancing a conventional loan and develop a cash shortage that puts them at risk of not making supplier payments, payroll or covering other everyday expenses. A startup might be waiting for a new equity investment deal to close, and may realize that they won't have the cash on hand to pay for marketing or equipment, or to cover the cost of product development. As a last resort, these small businesses may be able to access a source of cash that lets them meet their commitments, and keep their businesses afloat, until the anticipated influx of capital funding arrives. Short-term bridge loans can literally span these gaps in financing.
The Drawbacks of a Bridge Loan
The terms of a bridge loan are often not ideal for the small business owner. These are short life-span notes of anywhere from 30 days to nine months in duration, and they typically carry interest rates ranging between 7% and 12%. Security, in the form of business assets such as receivables, equipment, real estate or intellectual property, can be required to obtain this form of small business funding. A startup may have to offer warrant coverage, a percentage of the loaned amount that the investor can buy in company stock, as an incentive in order to get the capital needed. Origination fees, often 1% or 2% of the loan amount, may be charged. An investor willing to provide a bridge loan may even add in restrictions on how the business can spend and invest during the loan period. Owners may have to use personal collateral, putting them at risk of losing not only their business, but a home or other fixed assets, if they default on the loan.
How to Obtain a Bridge Loan
If you own a well-established business with a good credit history, a solid cash flow and a demonstrable means of repayment, your bank may be willing to work with you to arrange bridge financing. They'll need proof that your business has the available income to cover loan payments, and they may require collateral. Another way to obtain short-term cash is through a factor; a company that will loan a small business a discounted percentage of their receivables. Startups may have much greater difficulty in finding a source of short-term funds. An equity investor who already has a stake in the health of the business may be the best option. If the business has an expected equity investment from several sources, letters of intent (LOI) from these parties could be enough to solidify a much-needed bridge loan.
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