Bridge Loan Issues – Analysis & Recommendations

Many clients seeking project financing commonly ask for “Bridge Loans.” Usually, this means simply a smaller loan for a preliminary project stage before they can prepare, qualify for, or obtain a full capitalization loan. While “Bridge Loans” are in demand and frequently requested by clients and brokers, there is a compelling reason why that loan is complicated for financial institutions to arrange reliably as part of Funding Support services.

?Bridge Loan Issues and Challenges

A “Bridge Loan” is a “loan against a future loan.” The only way to get one is to prove to the Bridge Lender that you have a solid, binding Loan Commitment for the entire project funding loan. This is necessary to show the lender that there is a certainty that the project launch will be completed, and thereby, revenues will be generated, allowing repayment of the loan.

Unfortunately, most institutional lenders no longer give “commitments” like that. (They are more likely to provide you with the actual money before they would give a “commitment” letter.) Significant changes in banking laws and regulations since 2006 made it essential for banking and financial institutions to provide any “commitments, “terms sheets or even “LOI” unless a specifically identified collateral, proven revenue stream, or binding exit strategy is already in place, and the project is fully underwritten, certified and bankable.

Of course, if the client already has all those advantages, it would be qualified to be approved for the entire project immediately. It would thus not need the “Bridge” loan for only a preliminary stage. As a result, it is commonly considered “easier” to get the whole project loan for 100% of working capital and get the actual money than ever to get “only a commitment” to prove what is required to get any “Bridge Loan.”

The only exception to this dilemma is if the client already has a solid, binding, verifiable Loan Commitment for the entire 100% project capital from a lender and is looking for an actual “Bridge Loan” in the proper sense of its original meaning. (Since institutional lenders generally refuse to give “commitments,” this is usually possible only if the lender is a private fund source. If there is a special pre-established relationship between the client and lender, and often when an institutional lender commits to funding, it gives a remote funding date many months later.

In the rare and unexpected case of the client already holding a real commitment, most financial services professionals and firms are unprepared to help. The reason is that many clients seeking a bridge Loan” are not qualified, making it impossible to obtain, so service providers usually do not try to develop a network of Bridge Lender sources. The holder of a legitimate Loan Commitment, however, would or should be able to use that as the basis for a Bridge Loan or ordinary advance or factoring loan with almost any available source without needing the help of any intermediaries or financial services.

?Mezzanine Finance as an Alternative

What most clients mean, when they are misled to believe that they should ask for a “Bridge Loan,” is technically not that at all, but rather simply preliminary funding for an early stage of the project to position the company to be attractive for a total budget of the remaining steps. The correct term for this is “Mezzanine Finance.”

Mezzanine Finance shares the same problem for Loans. Getting a “loan against a future loan” is tough when the client cannot prove it has secured a future loan. The Mezzanine has the additional challenge of funding only a preliminary stage of the project, with no assurance or “guarantee” of later receiving the total budget that will allow the project to be completed and generate revenues. To overcome this, it is necessary to prove that the preliminary stage will generate enough income to repay the Mezzanine Loan.

Accordingly, Mezzanine Finance is also highly challenging to obtain from an institutional lender but is more feasible from private sources, such as either venture capital (VC) firms or investment funds. Such references usually want equity participation and many more controls to ensure the project is implemented enough to achieve revenues to repay the funding. Also, it is necessary to prove that the preliminary stage is designed and capable of generating enough revenues, using only the Mezzanine level fund. In short, the first stage being funded by Mezzanine must be like a self-contained “mini-project” that is profitable in some way all by itself.

The most reliable way to obtain Mezzanine Finance as a loan is to package the “preliminary” stage of the project as a self-contained, smaller project. This allows you to apply for ordinary project financing through regular channels. This also requires collateral asset backing and certified banking compliance documents, and thus, the same effort and cost expense of qualifying to obtain a loan against the larger project.

?Seed Capital Fund-Raising as an Alternative

When all financing avenues appear closed, from lack of prior commitments, incompatibility of the preliminary stage to be a “stand-alone” mini-project or absence of available working capital, all efforts must be concentrated on raising See Capital. All companies seeking financing are generally required, or at least strongly expected, to already have collected significant seed capital. Private lenders and investment funds almost universally need companies to have substantially self-invested or collected Seed Capital. Some institutional lenders often require the applicant to self-fund from 10-30% of the loan amount as a “down payment,” proof of funds (POF) or proof of capability. Having Seed Capital proves some of the following: (1) the company is solid enough to be “worthy” of funding. (2) the project has won support from professional colleagues such that a lender should also believe in it, and (3) the founders believe in the project so much that a lender can trust them to implement it to generate revenues and repay the loan successfully.

The most common sources of Seed Capital are the company founders, “friends and family” circles, private individuals, or corporate investors, including professional colleges and industry experts, who can typically contribute approximately $100,000 each to provide some preliminary operating capital.

Such an amount can reliably cover retainers for the licensed banking institution services, legal work, collateral procurement and other financial services to make the clients bankable with collateral or asset backing. That lower level of “micro-finance” effectively allows a licensed institutional service to prepare and take a client to the total funding package for the entire project.

?In standard practice, financial services professionals, firms and institutions are “not set up” to assist clients with raising Seed Capital. Generally, no funding source can “give” that opportunity to a client. Professional references must concentrate on large-scale total project funding. They cannot dilute or divert their resources to pursue minor private investors or relatively “nominal amounts (compared to the tens and hundreds of millions of project funding package amounts).

Traditionally, raising Seed Capital is something that project principals are required and expected to achieve “on their own,” on a personal level, tapping into their own life, career, professional and other networking resources. One alternative method for financial services institutions, primarily as intermediary facilitators, is indirectly assisting clients with raising Seed Capital by showing strong “support.”

?As a guideline, it is suggested that participating Bank Consortium member firms can issue or arrange various “letter of intent” (LOI) documents to clients. This can include an “Underwriting Pre-Approval,” a “Conditional Approval,” a more advanced “Conditional Collateral Backing” LOI, or a similar written statement showing practical and infrastructure support for future funding on an institutional level.

It is recommended that all such statements be made “conditional” upon the client later engaging the licensed financial services referenced as the available support.?This preserves the truthful and transparent disclosure to Seed Capital Investors that such support will only be realized once the client uses Seed Capital to engage the required services.

?