28 Apr Bridging Finance: What is it and how does it work?
An opportunity suddenly materialises in your business that cannot be missed. It holds strategic importance and seizing the opportunity will magnify the potential value and / or cash flow of your business beyond the value of the opportunity itself as a standalone venture.
It could be buying the farm next door that perfectly compliments the existing farming enterprise. It could be buying land for future strategic development. It could be buying a competitor’s business and vertically / horizontally integrating core activities to improve overall gross margins. Or it could simply a partnership buy out just to name a few.
Two key resources are required when events like this generally occur. You need to move quickly, and you need access to capital.
On the rare occasion a business may already have access to the capital which then solves the issue of “speed to market”. But if the opportunity is substantial, then this is more an unlikely situation than the norm.
Bridging finance can take many forms, but in summary it assists in taking a business on a journey from A to B with certainty, but with the added notion that the finance sought is temporary (6 months to 2 years). Once the journey to “B” has materialised, the bridging finance is then either repaid or refinanced into more strategic and cost-effective structures.
Bridging finance is called “bridging” because it funds the gap in the capital requirement equation. It would be fair to say that most business owners would have access to their business bankers. And without question, Australia’s major banks are the cheapest form of debt capital. But they are the cheapest because they operate under a very conservative legislative framework to protect mum and dads term deposits. They do not take existential risks to support a client’s hypothesis regardless how confident the client is of execution and completion. (Note: assuming that the funding being sought falls outside of standard bank policy). On the flips side to this point, the bank may have the capacity to (eventually) fund the proposal, but the due diligence timeline does not allow effect this proposal in a manner that secures the opportunity. Borrowers must be sensitive to this position when taking their funding options into consideration.
A secondary market constituting specialised capital (private & institutional) has developed to fund these circumstances. They have constructed a more commercial policy structure for business borrowers to access bridging finance under a mandated framework that clearly defines the acceptable opportunities (industry, enterprise, asset class etc), the cost of carry, the execution, the security, and the exit.
Bridging finance may have more flexible structures to meet the borrower’s circumstances. The interest may be capitalised through out the term of the loan to allow the execution of the strategy reach its conclusion without placing pressure on cashflow. It could be a discounted coupon with a Payment in Kind at the maturity date. It could be staged drawdowns to meet committed capital payments. Some of these terms provided by specialised lenders may not available with the major banks for the particular enterprise in question.
Bridging finance is higher than standard bank borrowing costs, but strategic borrowers evaluate the added costs holistically. They compute the aggregated value and benefits the acquisition holds vs the additional cost. Noting that the bridging finance is a temporary position within the timeline of a business and where the opportunity itself may be perpetual, hence negating the additional costs or at least nominalising them.
There are usually two kinds of exits from Bridging Finance.
- The first is a liquidity event. The acquisition being funded is then succeeded with a sale of an asset to pay out the bridging finance. If this sale event was not contractually defined prior to the acquisition, banks struggle with the determination of the exit, whereas specialised lenders can capture the event.
- The second is a cash flow event. Once the execution risk of the transaction is completed, and the economics of the transactions translates into higher profitability as predicted by the borrower, the borrower may have the capacity and the time to refinance the bridging finance back into mainstream banking.
Debt capital beyond the realm of traditional banking can open up a multitude of opportunities for businesses to expand with significant funding restrictions. With bridging finance, “execution” and “exit” are the two key areas for management to control, the rest is around good financial structuring to ensure the project is fully funded from the onset. If the long-term economic benefits vs risk vs short term cost of capital is positive, then the venture is worthy of serious consideration.
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