How Does Bridge Financing Work

Bridge financing is a short-term loan that a business can use to navigate a financially difficult period. This temporary financing can cover necessary costs until longer-term financing is achieved, hence acting as a ‘bridge’ between other finance solutions.

Bridge loan financing is usually offered by either investment banks or venture capital firms. It is expensive due to the higher risks associated with such loans, but there are several options available to suit different circumstances.

Types of bridging finance solutions

There are multiple ways a business can use bridging finance to secure funds to cover short-term costs. Usually, the available options will depend on the company’s credit profile and history, and their projected success. There will be more options open for firms that have either a good credit history or at least a solid market position. 

Desperate companies on the verge of collapse if they don’t secure bridge loan financing will have fewer options. They will probably have to accept higher interest rates and other provisos to protect the lender’s investment.

The main three types of bridging finance are:

• Debt bridge financing

• Equity bridge financing

• IPO bridge financing

Debt bridge financing

The most straightforward bridge loan financing solution is a basic short-term, high-interest loan. A business will need to ensure the loan will see them through the difficult period as the high interest rates will be problematic if their finances do not then improve. With these basic bridge loans, the better the business credit rating of the borrowing company, the better the terms will be.

Equity bridge financing

Companies seeking bridging finance can avoid incurring high-interest debt by offering a venture capital firm some equity in lieu of monetary repayment. This can be a good option if the company is well positioned to keep growing and become ever more profitable. A venture capital firm is unlikely to agree to a loan if they do not forecast a significant improvement in the borrower’s fortunes.

IPO bridge financing

Before a company makes an IPO to sell shares in the business, there can be a period of financial difficulty. Here a bridge loan ensures they stay afloat until the IPO is complete and shares in the business are sold. The loan should then be repaid with the money made from sales of the shares after the IPO is complete. Shares can also be offered to the lender at a discount to offset the loan.

Bridging finance terms and conditions

Although bridging finance is expensive due to the much higher interest rates or equity required to secure the loan, each case is unique and can sometimes be cheaper. It will depend on each transaction, the market position of the borrowing company and the risk involved for the lender. 

Other influential factors include how the bridge loan financing will be repaid and the time frame involved before the initial drawdown.  

The interest rate for most bridging finance loans will usually range between 0.5% and 2% a month. Often there is also an arrangement fee due to be paid to the lender to arrange the loan in the first place, which can be as much as 2% of the total loan amount. 

Lenders will also include certain provisos to protect their investment, such as exit fees and a minimum interest clause. The latter ensures the lender receives the interest for a specified period regardless of any other developments, such as early full repayment or paying an exit fee.

The time frame of a bridging finance loan is usually between six and 12 months. Each instance will have various options for repayment, such as repaying the interest each month, but waiting until the agreed time frame expires before repaying the whole loan in full. Some lenders will allow the borrower to ‘roll up’ the interest so they pay off the loan and the interest together at the end of the specified time frame.

We can help

If you’re interested in finding out more about bridging finance solutions, or any other aspect of your business and its finances, then get in touch with our financial experts. Find out how GoCardless can help you with ad hoc payments or recurring payments.