Securing a Bridge Loan The ABCs on what a bridge loan is, why you should think about getting one and how to do it
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Bridge loans are short-term funds that "bridge" the gap between today's need for immediate cash to pay bills and the final closing of a pending investment deal or long-term financing package. Firm owners can go to banks for such a loan if they have a solid cash-flow position and the bank feels comfortable with the level of monthly sales as sufficient to support the loan for 60, 90 or 120 days. The bridge can also be provided by a factor, a firm that agrees to provide front-end cash on specific accounts receivable that meet certain credit requirements on the part of the payer. The factor will typically provide 50 to 70 percent of the face value of the invoices upfront, and the balance of the funds will be paid to the entrepreneur at the collection date on the receivables. However, the factor takes a hefty fee or interest charge for this bridge.
Equity investors are also open to providing bridge loans. If a major equity funding deal is pending final logistics until it closes in 90 days, sometimes the funding group will make a short-term bridge loan in advance of the closing on the stock purchase. Sometimes this bridge loan financing is in the form of a convertible note that will either pay the lender interest only during the bridge period (no principal due until the long-term equity deal closes) or some combination of interest and principal. The conversion feature is a call option that will allow the lender to choose to either have the loan paid off (any fees, interest and the full principal) or roll the loan into an additional equity stake in the longer-term funding package. This often occurs when the bridge is for 180 days and the company's sales and profit prospects improve dramatically during those six months due to securing a major new client, moving into a great new facility or recruiting top-level management talent.
But what about the situation where the company needs cash right now to pay bills, and the future equity deal is not coming from one capital funding source, but from several smaller angel investors? Is it possible to arrange a bridge loan today that is provided in lieu of the aggregate capital that is coming in a few months from different individual investors? The answer is yes! The entrepreneur can utilize letters of intent (LOIs) to put together a short-term bridge loan. Consider the following example:
A small firm is in the middle of closing a "B" round of equity funding during the second year of operations. Four individual investors have agreed to purchase stock in the company in these amounts on these dates: investor A, $25,000 in two months; investor B, $30,000 in four months; investor C, $25,000 in two months; and investor D, $15,000 in three months. Together, these four investors are providing more than $90,000 in new equity capital for the firm, but the total will not be entirely in-hand for another 120 days. The company has new marketing and promotions contracts to pay, and equipment to purchase, over the next three to four months, totaling $75,000 as part of the growth plan for this funding. The entrepreneur will not be able to get a bank to do the bridge loan due to insufficient monthly cash flow to service the debt, and a factor is not interested in promises made by "potential" equity investors. But another equity investor, a family member or one of the four angels could be approached about fronting the company a $90,000 bridge loan for 120 days, and the earnest for the funds would be the signed LOIs from the four investors.
Such a deal might require the bridge loan originator to meet face-to-face with the four angels to confirm their signatures and the terms of the LOIs, as well as hear firsthand their intentions to invest in the firm. Of course, an LOI is generally not a binding contract between the angel investor, the entrepreneur and his or her firm. If the bridge loan is made and the angels do not come through with their proposed investments, the bridge lender cannot recoup payment on the loan from the angels based on the LOIs. However, the relative strength of the LOIs can serve as a solid basis for securing a bridge loan, especially if the lender is also one of the angels who is willing to cover the entire funding amount for a short-term period, and then remain an equity investor on his or her portion of that after the others invest and the entrepreneur repays the bridge loan.
David Newton is a professor of entrepreneurial finance and head of the entrepreneurship program, which he founded in 1990, at Westmont College in Santa Barbara, California. The author of four books on both entrepreneurship and finance investments, David was formerly a contributing editor on growth capital for Industry Week Growing Companies magazine and has contributed to such publications as Entrepreneur, Your Money, Success, Red Herring, Business Week, Inc. and Solutions. He's also consulted to nearly 100 emerging, fast-growth entrepreneurial ventures since 1984.
The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.