Temporary Loans, A Bridge to Nowhere?

Sometimes, a business will request a short-term note to get them by from today until a certain event occurs in the not-too-distant future.  These are often called bridge loans.  These are designed to bridge the gap between when cash is needed and the known event that provides the repayment on the debt. 

The most common type I have come across is a construction loan where another institution has committed to financing the finished product.  The borrower will need funds to have the product built and obtain the local authority’s stamp of approval, before the permanent lender is willing to take over.  If you have ever financed a construction loan portion of a SBA 504 take out commitment, you have done a bridge loan.  In fact, any temporary financing of the SBA 504 loan, construction involved or not, could be through of as a bridge loan. 

The loan should be underwritten assuming if the backside financing does not materialize.   Can the lender be comfortable in financing the entire project?  What happens if the 504 loan does not fund?  The lender should underwrite this as a backup plan.

The second type usually involves an order a company has received which is out of the ordinary.  There is typically enough profit margin or other future value for the business owner to consider the request.  Completing the order will require extra cost for material, labor, and overhead the company would not incur and may not have now, if they elected to not complete the order.  I worked with a road contractor who landed a large project with the state for highway work.  The work required additional resources outside of their existing operating line to complete the work. 

This required several points to analyze that one typically does not see with a standard loan.  First, can the company execute on the contract?  Does the company have a history of past experience with this type of work?  What if the contractor could not get necessary materials to complete the job?  What about work stoppages?  Proper permitting?  Could the lender have funds outstanding on the bridge loan when the company is not able to finish?

Next, can the customer, in this case the state, are they able to provide timely payment on the contract once completed?  The state may be certain to pay, though it may be slow.  A buyer in a weaker financial position may not be able to fulfill his obligations on the order. 

If the product is not produced or payment is not made, what other impacts will there be on your client operationally, financially, or reputation-wise? 

Each case requires the analyst to assess the back-up plan and underwrite that to terms of an acceptable loan in terms of structure, guarantees, and collateral.  If you cannot create a reasonable structure if the event does not occur, then you will have a problem loan if things do not materialize as planned.  If you cannot create a fall back financing plan that works, perhaps it is best to pass on the opportunity. 

The maturity of the loan should match the expected time of payment.  Don’t just look at a 3 or 6-month term.  If the payment is supposed to hit 101 days from the day of closing, select a term to match that to help the line police itself.  Since these terms are short and there may be a higher risk to the credit, the lender should charge a larger fee.  The interest should be on a variable rate to keep the margin intact.

Don’t go into a bridge loan without collateral.  Consider taking a negative pledge on the asset involved in the event.  Take additional collateral to shore up the risk and help prevent the borrower from leveraging other assets if the cash flow gets tight. 

When it comes to a bridge loan, the lender should remember Murphy’s Law, “If something goes wrong, it usually will, and at the most inopportune time.”  Given this, understand your backup lending plan, structure the loan correctly, get substantial collateral, and get paid for your risk.  In the end, you will be pleasantly surprised if things work according to plan and adequately protected if your bridge loan turns into a permanent financing vehicle.