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:
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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.