Understanding Bridge Loan Terms

Many companies need a helping hand when they are struggling to tide them over until business picks up. A bridge loan is a common means of business financing for just that purpose. Before diving into a bridge loan, however, it is important to understand all it entails.

What is a bridge loan?

First, a bridge loan – also known as a swing loan or gap financing – is a temporary business loan using collateral such as real estate or inventory. The collateral could also be receivables, fixed assets, or intellectual property. The interest rates tend to be steep because of the risk associated with the short terms – they typically must be repaid in just one year.

And in some cases, bridge loans are made by venture capitalists who want to be repaid with company stock instead of cash. With this type of convertible debt often come special loan terms that determine how that equity is to be handled. A valuation cap, for example, protects investors from losing a portion of their equity share because the conversion price of the debt grew during the bridge period. With a cap, investors are guaranteed a certain percentage of equity before any more funding rounds can occur.

There are also investor-friendly discounts on bridge loans. This is an agreement to give the investor a discounted price on shares in the next round of financing. Warrants are another special term that gives investors the right to buy up shares from the company in the future at a pre-set price.

Example of bridge loan

So if an investor loans $100,000 and has warrant coverage of 100 percent, then he or she can buy up to $100,000 of company stock. The warrant coverage is used between 50 percent and 100 percent but can be as high as 200 percent.

While the terms can be onerous at times for business owners, the temporary and quick influx of cash from a bridge loan can be a lifesaving vehicle when times get tough.


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