A bridge loan is a short term financing facility offered to a borrower before he obtains permanent funding for the finance of a project. Funds from bridge finance are therefore expected to be repaid when permanent funding has been obtained. Bridge Financing is mostly utilised for big real estate projects or projects requiring huge capital outlay at the initial, middle or completion stages. It can also be used for the initiation or completion of smaller projects.
Suppose you are in the middle of a project that you have so far funded on your own. The project is set to cost you N10million and you have to date spend N6m on conceptualization, design and development. Now you need another N4million to help with implementation, marketing, storage and distribution. You have already received orders for your product to deliver within 8weeks. You have approached venture capitalist or angel investors who have shown interest in funding the balance N4million. However, as is mostly the case, it is taking too much time as investors like to perform due diligence and other background checks before investing. Thus, affecting your chances of delivering on the job.
A mostly used form of closing such funding gap is a bridge finance. You can approach a bank to fund the N4million that you need with a view to repaying the loan once your permanent funding is in place. To assuage the concerns of the banks you will have to provide information that shows that the Venture Capitalist (VC) or Angel Investors have indicated a firm interest to invest in your company. This maybe via a letter called an “Indicative Offer” from the Investor or any document showing that a deal to attract a more permanent investment have gone past the M.O.U Stage. Quite often the letter of intent will be accompanied by an advance payment of the amount to be invested by the investor serving up as a show of commitment.
For example, the VC can agree to drop 25% of the N4m, pending when the terms of the deal have been firmed up. Another comfort for the banks is the proof that you already have orders for the products. This tells the banks that even if the VC’s come short, the project can repay the loan from the sale of its products.
Bridge loans are usually repaid when the permanent funding for the project is secured. Using our example above, the bridge loan will be repaid once the company gets the N4m equity investments from the Venture Capital or any potential equity investor. However, some banks may request that the bridge loan be repaid from periodically from any other source irrespective of whether the permanent funding will be received.
What about Collateral?
In most cases it does not require the borrower to provide a high level collateral for the funding. Collateral for the funds are mostly the permanent funding that is being expected. However, some banks may require that an all assets debenture be provided on the entire project, which serves up as collateral. That way the bank can take over the project and sell it should the borrower default in repayment. Whilst landed assets and properties may also be required it maybe waived depending on the viability of the project or the ability of the borrower to show firm commitment that money will be received from new investors.
Tenor of the loans
As indicated, Bridge Loans are short-term in nature and can be structured from 3 – 12months depending on when permanent funding will be expected. It may also depend on the timing of the deployment of funds for the project. For example, the funding may be required to be utilized over a period of 3 months, in which case the tenor can be structured accordingly.
Cost of the funds
Bridge-Loans are by nature risky and may attract higher interest rates than term loans. In Nigeria interest rates will usually be a 4-6% margin on the Inter Bank Rates depending on the risk profile of the project. Don’t be surprised to be asked to pay as much as 21% for bridge loans in Nigeria.
When should I get a bridge loan
A bridge loan should be obtained once there is a reasonable believe that equity or a permanent form of funding will be obtained in the short term. Failure to time the funding may result in the borrower paying high interests which may jeopardise the viability of the project in itself. Remember, the loans will be repaid from the permanent funds expected. It should also be obtained when you are sure the funds is critically required for the project to continue running without hindrance. There is no point obtaining a bridge loan when the funds cannot be utilized immediately.