Effective Use Of Bridge Financing
Bridge financing applications are usually short in duration and effectively create a financing bridge from one activity to another. The activities can be related or unrelated as I will discuss in more detail.
An example of a closely related transaction requiring bridge financing is a construction project. Say you are an owner of a business and you’ve recently purchased a parcel of land for the purpose of erecting a commercial building to house your operations.
Your bank wants to provide you with a long term commercial mortgage once the construction is complete, but is not interested in the actual construction financing. So a construction loan is required from a separate lender to finance the construction period. In essence, the construction loan is bridge financing, providing you a bridge to the long term commercial mortgage you desire.
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Now not all construction projects require two lenders. However, even in situations where one lender will finance construction and the finished asset, two separate loans are usually still required to reflect the differences in risk between building something and financing something that already exists.
Loosely Related Transaction
An example of a loosely related transaction would be if you had already sold an asset and while waiting for the transaction to close you were trying to upgrade to a newer or larger version of the same or similar asset.
In this case, we’re saying that the upgrade purchase will require equity from the pending asset sale to close the deal. But because proceeds from the asset sale will not be made available until after the time the purchase needs to be completed, bridge financing is required.
Because of the similarity of the assets, the business need for upgrading, and the likelihood of prompt closing of the asset sale, certain lenders would seriously entertain providing some sort of bridge financing.
I say that these transactions are loosely related because they are actually completely separate transactions, but because of the type and use of the asset, the connectivity between the two transactions helps promote the possibility of a bridge financing loan.
Unrelated Transaction
Building on the last example, you may have entered into a transaction that has not yet closed and you want to leverage the expected unencumbered proceeds you will receive to assist in the financing of one or more totally unrelated transactions.
This scenario can exist when a business is trying to expand, change its business focus, enter into a new venture, downsize its operations, etc.
Any time a business is in a state of change, it’s financing capacity can be stretched to the limit and a financing bridge may need to be utilized to move from one state of operations to another.
Most small and medium sized businesses don’t have unlimited resources, so being able to manage through these transaction periods are critical for companies going through either growth or divestiture.
This is where bridge financing comes in.
The nature of a financing bridge where related or unrelated events are leveraged to facilitate timely business transactions is that it tends to be more expensive that conventional financing due to the inherent risk and it can be difficult to locate and secure, depending on the nature and complexity of the transactions in question.
The key elements of bridge financing are:
- Length of time
- Location
- Amount of funds required
- Nature of transaction
- Terms and conditions of transactions
- Underlying market for the assets involved
- Financial strength of the borrower
Bridge loans are predominantly provided on real estate based transactions with a high probability of timely closing.
Some types of asset based loans like pruchase order financing can also be considered bridge financing due to the loan structure and term.
Like most financing activities, most bridge financing opportunities are not well thought out or planned in advance, leaving the potential borrower trying to find a financing bridge before time runs out on the deal they are trying to close.
Rushed financing almost always creates anxiety in lenders effectively reducing the total amount of interested financing sources and driving up the price of those that remain.
The best solution is to outline your strategy well in advance and use the information to educate potential lenders so they have adequate time to assess the opportunity and to provide you with valuable feedback as to any key elements they would need to see in the transaction(s) in order to consider a formal financing application.
By taking a proactive approach, you also put yourself in a better bargaining position in terms of fees and rates; basically the more appealing you can make your bridge financing scenario, the more competitive interest you can create among prospective lenders.
