Cash flow is the lifeblood of a business. Even a successful business will fall into ruin if it cannot manage its cash flow correctly. In fact, it remains the leading reason why businesses of every size close their doors for good.
According to a recent article, 82% of businesses fail due to cash flow issues. However, cash flow issues can be resolved through clever use of financing. Commercial bridging loans are one example of the financial tools managing directors have to leverage themselves out of temporary cash flow problems.
In this guide, we discuss what these loans are, how they work, and whether they are suitable for your business.
What is a commercial bridging loan?
Commercial bridging loans are termed as such because they are used by businesses to take advantage of immediate opportunities, including purchasing:
· Buy-to-let property
· HMO properties
· Property refurbishments
· Land purchasing
· Commercial property deposits
Due to the short-term nature of commercial bridging loans, they are generally processed in a matter of days. However, unlike traditional loans, they come with short payment terms, meaning they are not long-term solutions.
Businesses that understand the value of the £10.9 billion bridging loans market put themselves into a position whereby they can leverage time-sensitive opportunities and achieve higher growth rates.
How does a commercial bridging loan work?
Commercial bridging loans represent a temporary source of capital that companies can use to cover various immediate expenses, such as purchasing or refurbishing a property. It’s typically secured against an existing property or the property that’s been purchased.
Typical loan terms range from a few months to a year, giving businesses time to refinance or sell a property and repay the loan.
For example, property development companies often rely on commercial bridging loans to cover the building costs of new projects. Once the building is completed and sold, the loan is repaid in full, with any profits retained by the business.
How does interest work?
Commercial bridging loan interest rates are often higher than traditional loans because of the elevated risk to the lender. In most cases, the interest is “rolled up” and repaid alongside the principal at the end of the loan term. This means that you don’t have to make any monthly repayments.
The different types of bridging loans for businesses
Bridging loans for businesses are a specialist type of financing designed to help businesses take advantage of opportunities and bridge temporary cash flow gaps.
It’s becoming more common for businesses to use specialist products like this because the idea of “too big to fail” no longer exists. It’s why Forbes found that 50% of Fortune 500 companies in the U.S. that existed 20 years ago have disappeared.
With that in mind, there are two primary types of bridging loans for businesses:
1. Open Bridging Loans – These loans don’t have set payment dates, giving businesses more flexibility. However, open bridging loans are still expected to be paid within a year.
2. Closed Bridging Loans – Closed bridging loans act like traditional loans with fixed payment dates.
Which type of bridging loan is best suited to your firm depends on what you need the money for and your short to medium-term plans.
What do businesses use bridging loans for?
Businesses use bridging loans for any project requiring a short-term injection of capital. Most commercial assets can be bought using bridging loans. Some examples include:
· Buying new businesses
· Commercial property
· Mixed-use property
· Brownfield sites
· Dilapidated commercial premises
· Funding startups
Bridging loan examples
How do bridging loans work in the field?
One example could be a property development company that has sourced a dilapidated commercial property at a knockdown price. The problem is that obtaining a traditional mortgage on these properties is nearly impossible.
Instead of letting the opportunity pass them, they opt for a commercial bridging loan to secure it quickly. They renovate the property and then sell it at a profit or refinance with a long-term mortgage to repay the loan.
Another example could be a growing retail business looking to expand. The problem is that the property is highly coveted, and people can’t afford to wait for traditional financing. Commercial bridging loans enable a quick purchase. This allows them to set it up and start generating revenue fast. They pay back the loan with a long-term business loan or mortgage.
How are bridging loans paid back by businesses?
Bridging loans come with several repayment options. Ultimately, most bridging loans are only repaid (with interest) at the end of the term unless the loan has an open repayment date.
The most common approach for paying back business loans is to use the proceeds from selling a property to pay the loan in full. However, if this isn’t possible, various refinancing options become available.
For example, a business could secure a mortgage on a refurbished property. Another option would be to take out a business loan with a longer term to essentially “replace” the bridging loan.
Qualifying for a commercial bridging loan
Eligibility for commercial bridging loans depends entirely on the lender, and applications are assessed on a case-by-case basis. However, let’s examine the factors all lenders will consider.
Security Value – Most securities for these loans come in the form of semi-commercial or commercial properties. Some lenders may accept other assets as security, but property is the standard currency for these loans.
Exit Strategy – Viable exit strategies are crucial for these loans because lenders want assurances they’ll get their money back. Strategies can include property sales, remortgaging, or revenue.
Loan–to-Value (LTV) Ratio – LTV is a metric used to determine the maximum amount a lender will offer as part of a loan. Generally, the LTV is 65-70% maximum, meaning if you have a £200,000 property as collateral, you can borrow a maximum of £140,000.
Credit Score – Your credit history is another factor to consider. However, since this loan is secured against an asset, it doesn’t have the same impact as other forms of loan. Ensure you are upfront with your lender if you do have a poor credit history, though.
Overall, qualifying for a commercial bridging loan is about showing a viable exit strategy and providing sufficient security for it. It may take some shopping around, but this growing market offers options for most business applicants.
What are the interest rates of a commercial bridging loan?
Every lender will set their own interest rates. Since these loans are short-term arrangements, interest rates are calculated using monthly rates rather than the Annual Percentage Rate (APR) used for other loans. Note that interest may be fixed or variable, depending on the lender.
Repaying the interest comes with three options:
Monthly – Pay the interest every month.
Rolled–Up – All the interest is bundled up and repaid at the end of the loan.
Retained – Retained interest means the amount you borrow is used to repay the interest monthly, meaning everything is paid at the end of the loan term.
Tax implications of commercial bridging loans
Tax implications are another factor to consider, so we recommend speaking to a professional tax advisor. How your loan is treated in the tax ecosystem depends on what you’re using the loan for, your business structure, and more. However, most businesses will find that any interest paid is fully tax-deductible.
The pros and cons of commercial bridging loans
Are commercial bridging loans right for you?
It depends on what you want the money for and your goals. Let’s run through the basic pros and cons of these loans.
Pros
· Quick access to capital
· Deferred payments
· Flexible terms
· More accessible
Cons
· Higher interest rates
· Higher fees
· Must be repaid quickly
· Collateral required
Is a commercial bridging loan right for your business?
Commercial bridging loans are best used for projects requiring short-term financing that can be turned over within a year. Ultimately, these are stopgaps for taking advantage of opportunities that won’t wait around.However, with so many financing options available, including alternatives to commercial business loans, it’s vital to speak to an expert. At Hilton Smythe, our team of business experts support countless businesses in planning for the future. To learn more, speak to our team for your free consultation today.
