What it means
The name describes the function: the loan is a bridge from where the borrower is now to where it expects to be shortly, when a defined event will produce the cash to repay it. That event, called the exit or take-out, is the heart of the credit decision.
A lender providing a bridge cares less about the borrower's ongoing cash flow than about the certainty and timing of the exit: is the property sale agreed, is the equity round documented, has the bank committed the term loan? Bridge loans have distinctive terms.
They run for a few weeks to about a year, often with the option to extend at a fee. Interest rates are high, commonly several points above a term loan, and frequently charged monthly or rolled up and paid at exit.
Arrangement fees of 1% to 3% are usual, and exit fees are common. Security is typically a first or second charge over property or other assets, and in corporate bridges a lender may take warrants or a conversion right into the equity round the bridge is supporting.
Repayment is normally in full from the exit proceeds. In the corporate world bridge financing takes several forms.
Investment banks provide acquisition bridges: a commitment to lend the purchase price so that a buyer can sign a deal, with the intention that bonds or syndicated loans will replace the bridge within months. The bridge is drawn only if the permanent financing is not in place at completion, and the fees escalate the longer it remains outstanding, which gives everyone an incentive to refinance quickly.
Venture-backed companies use bridge rounds, often convertible notes from existing investors, to reach a milestone that will support a priced round at a higher valuation. Companies awaiting a large contract payment, a tax refund or an insurance settlement use bridging to keep operating.
The risk is that the bridge becomes a pier. If the property does not sell, the round does not close or the bond market shuts, the borrower is left with expensive short-term debt and no way to repay it.
Extensions are costly, and a lender with security will eventually enforce. Prudent borrowers arrange a bridge only against an exit that is highly likely and largely outside their own control to derail, and they model what happens if it slips by six months.
For finance teams, bridge financing is a tool for timing problems, not for shortfalls. It works when the borrower has the money coming and merely needs it sooner.
It fails when the borrower hopes the money will come.
In practice
Real-world examples.
Example
A homeowner borrows $400,000 for three months to complete a purchase before the sale of the existing house completes, repaying from the sale proceeds.
Example
A start-up raises $1.5 million in convertible notes from existing investors to reach the revenue milestone at which a new investor has agreed to lead a priced round.
Example
An acquirer signs a $500 million purchase supported by a bank bridge commitment, then issues bonds to repay the bridge before completion.
Think of it
“Bridge financing is temporary money to cross a gap-short-term capital until real funding arrives.
Formula
Calculation
Total Bridge Cost = Interest (Principal x Rate x Months / 12) + Arrangement fee + Exit fee + Legal and valuation costs
Effective Annual Cost = Total bridge cost / Principal x 12 / Months
Worked example. A company has agreed to buy a warehouse for $2,400,000 and must complete in six weeks. Its bank has approved a ten-year commercial mortgage of $1,800,000 but the bank's process will take four months. The company has $600,000 of its own cash for the deposit. It takes a bridge loan of $1,800,000 for four months at 1% a month, with a 2% arrangement fee and legal and valuation costs of $9,000.
- Interest = $1,800,000 x 1% x 4 = $72,000
- Arrangement fee = $36,000
- Costs = $9,000
- Total cost = $117,000
- Effective annual cost = $117,000 / $1,800,000 x 12 / 4 = 19.5%
Against that cost, the company weighs what it gains: the warehouse was priced $150,000 below comparable properties because the seller needed a fast completion, and missing the date would have lost the deal. Net benefit of bridging = $150,000 minus $117,000 = $33,000, plus four months of use of the building.
Slippage test: if the mortgage takes seven months instead of four, interest rises to $126,000 and total cost to $171,000, which exceeds the price advantage. The company asks the bank for a written timetable and the bridge lender for a fixed extension fee before proceeding, and confirms that the mortgage approval is credit-committee approved rather than indicative.Case study
Seen in the real world.
A manufacturing company won a $4 million government contract with payment on delivery, but needed $1.2 million of materials and labour to fulfil it over five months. Its bank declined to increase the overdraft on the strength of a single contract. The finance director arranged a bridge facility from a specialist lender secured on the contract receivable and on the company's plant, at 1.25% a month with a 2.5% fee, drawing in stages as costs were incurred.
Average drawn balance over the five months was $700,000, so interest came to about $44,000 and fees $30,000: total cost $74,000 on a contract with $900,000 of gross margin. Delivery was accepted on time and the government paid 30 days later, repaying the bridge in full. The finance director's post-completion note recorded two things.
First, that the company should have negotiated stage payments into the contract, which would have removed the need for the bridge and saved $74,000. Second, that having demonstrated the contract's completion, the bank agreed to a receivables finance line for future contracts at less than half the bridge lender's rate. The bridge had been expensive, but it had turned a contract the company could not otherwise have accepted into a profitable job and a better banking relationship.
Watch out
Common mistakes.
- Bridging against a hoped-for event rather than a committed one. The exit must be near-certain, or the bridge becomes permanent expensive debt.
- Comparing the bridge's monthly rate with an annual rate on term debt and concluding it is cheap. Convert to an effective annual cost including fees.
- Failing to model a delayed exit. Extensions are where bridge loans become ruinous.
Questions
People also ask.
How is a bridge loan different from an overdraft?
An overdraft is a revolving facility for ordinary working capital fluctuations. A bridge is a fixed-term loan for a specific gap with a defined repayment source.
Why is bridge financing so expensive?
The lender is paid for speed, for a short life over which fixed costs are recovered, and for the risk that the exit fails.
Can a bridge loan be unsecured?
Corporate acquisition bridges from investment banks often are, on the strength of the borrower's credit. Most other bridges are secured.
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