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How can you manage liquidity risk in bridge financing deals?

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Bridge financing is a short-term loan that helps a company or an investor to close a deal or fund a project until they secure permanent or long-term financing. It can be a useful tool to bridge the gap between cash inflows and outflows, but it also carries liquidity risk, which is the risk of not being able to repay the loan on time or at a reasonable cost. Liquidity risk can arise from various factors, such as market conditions, regulatory changes, operational issues, or contractual disputes. In this article, you will learn how to manage liquidity risk in bridge financing deals by following some best practices and strategies.

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Jayan S, ASA (Aust.)

Assistant Financial Controller @ Q2 Impact | CPA Australia, Financial Controlling

1 Assess the deal structure and terms

Before you enter into a bridge financing deal, you should assess the deal structure and terms carefully and realistically. You should consider the purpose, duration, amount, interest rate, fees, covenants, and repayment options of the loan. You should also evaluate the risks and benefits of the deal, such as the potential return, the exit strategy, the collateral, and the alignment of interests with the lender. You should avoid overestimating your cash flow projections, underestimating your costs, or taking on too much debt that you cannot service or refinance.

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Jayan S, ASA (Aust.)

Assistant Financial Controller @ Q2 Impact | CPA Australia, Financial Controlling
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To manage liquidity risk in bridge financing deals, businesses should conduct a comprehensive cash flow analysis, develop contingency plans, communicate transparently with stakeholders, diversify funding sources, negotiate favorable terms, implement robust monitoring systems, stress test for adverse scenarios, optimize working capital management, consider insurance coverage, and ensure legal and regulatory compliance. Adopting these strategies helps mitigate potential liquidity challenges and enhances overall financial resilience.

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NARAYANAN NARASIMHAN

Creating Successful Finance Operations
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To mitigate liquidity/cash risk, technology and IT companies should implement advanced cash management systems for real-time visibility into cash flow and liquidity. Utilizing predictive analytics aids in forecasting cash needs, allowing for preemptive action to ensure liquidity. Automating accounts receivables and payables optimizes cash flow, reducing liquidity shortages. Employing blockchain technology can also streamline transactions, shortening settlement times and improving liquidity management. This holistic approach ensures operational and financial stability by effectively managing liquidity risks.

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Stefano Passarello

Accountant and Tax expert | Crypto Tax Specialist | Board Member | Co-founder of The Kapuhala Longevity Retreats
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Before entering into a bridge financing deal, you should carefully assess the deal structure and terms. This includes the purpose duration, amount, interest rate, fees, covenants, and repayment options of the loan. You should also evaluate the risks and benefits of the deal, such as the potential return, the exit strategy, the collateral, and the alignment of interests with the lender.

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Peter Richard

Commercial Mortgages - We close the tough ones. Difficult property types and problem credit issues.
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Cash Flow Management: Thoroughly analyze cash flows to understand the timing of cash inflows and outflows. Ensure that there is enough liquidity to cover the bridge financing obligations during the interim period. Set aside reserve funds specifically designated to cover unexpected expenses or bridge financing repayments. These funds act as a buffer against liquidity shortages.

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2 Diversify your sources of funding

Another way to manage liquidity risk in bridge financing deals is to diversify your sources of funding. You should not rely on a single lender or a single type of financing for your deal. You should explore different options and alternatives, such as equity, debt, hybrid instruments, or asset sales. You should also maintain good relationships with multiple lenders and investors, and communicate with them regularly about your deal progress and performance. By diversifying your sources of funding, you can reduce your dependence on a specific market or counterparty, and increase your chances of securing long-term financing or refinancing.

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Stefano Passarello

Accountant and Tax expert | Crypto Tax Specialist | Board Member | Co-founder of The Kapuhala Longevity Retreats
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To reduce your liquidity risk, you should diversify your sources of funding. This means not relying on a single lender or a single type of financing for your deal. You should explore different options and alternatives, such as equity, debt, hybrid instruments, or asset sales.

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3 Monitor your cash flow and liquidity position

A key aspect of managing liquidity risk in bridge financing deals is to monitor your cash flow and liquidity position constantly and proactively. You should track your cash inflows and outflows, and compare them with your budget and forecast. You should also measure your liquidity ratios, such as the current ratio, the quick ratio, and the cash conversion cycle. These ratios can help you assess your ability to meet your short-term obligations and financial commitments. You should also identify and anticipate any potential cash flow gaps or shortfalls, and take corrective actions accordingly.

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4 Maintain a contingency plan and a buffer

Even if you have done your due diligence and planning, you should always maintain a contingency plan and a buffer for your bridge financing deal. A contingency plan is a backup plan that outlines the steps you will take in case of unexpected events or scenarios that could affect your liquidity or deal execution. For example, you could have a contingency plan for market downturns, regulatory changes, operational disruptions, or legal disputes. A buffer is a reserve of cash or liquid assets that you can access quickly and easily in case of emergency or opportunity. For example, you could have a buffer of cash equivalents, marketable securities, or credit lines.

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Stefano Passarello

Accountant and Tax expert | Crypto Tax Specialist | Board Member | Co-founder of The Kapuhala Longevity Retreats
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Even if you have done your due diligence and planning, it is always advisable to maintain a contingency plan and a buffer for your bridge financing deal. A contingency plan is a backup plan that outlines the steps you will take in case of unexpected events or scenarios that could affect your liquidity or deal execution.

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5 Negotiate with your lender and stakeholders

Finally, you should negotiate with your lender and stakeholders to manage liquidity risk in bridge financing deals. You should establish a clear and transparent communication channel with your lender, and update them on your deal status and performance. You should also seek their feedback and support, and address any issues or concerns promptly. If you face any difficulties or challenges in repaying or refinancing your loan, you should try to negotiate with your lender for more favorable terms or conditions, such as extending the maturity, waiving the fees, or relaxing the covenants. You should also engage with your other stakeholders, such as your partners, customers, suppliers, or employees, and seek their cooperation and collaboration.

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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Stefano Passarello

Accountant and Tax expert | Crypto Tax Specialist | Board Member | Co-founder of The Kapuhala Longevity Retreats
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In addition to the five main points above, there are a few other things you should consider to manage liquidity risk in bridge financing deals. These include: Conducting a thorough due diligence on the borrower. This will help you assess the borrower's financial health and ability to repay the loan. Obtaining a personal guarantee from the borrower. This can provide you with additional security in case the borrower defaults on the loan. Structuring the loan with a short maturity date. This will reduce your exposure to liquidity risk. Including a prepayment penalty in the loan agreement. This will discourage the borrower from prepaying the loan early, which could leave you with a liquidity shortfall.

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How can you manage liquidity risk in bridge financing deals?

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1 Assess the deal structure and terms

2 Diversify your sources of funding

3 Monitor your cash flow and liquidity position

4 Maintain a contingency plan and a buffer

5 Negotiate with your lender and stakeholders

6 Here’s what else to consider

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