Many investors appreciate the benefits of working with private equity companies and taking advantage of related investment opportunities, but when those openings arise, investors may not have the necessary capital immediately available. When the amount of needed funds is greater than the available monetary resources, bridge loans provide a solution. In other words, this financing option provides temporary help to cover short-term costs until regular resources become available. Bridge loans are sometimes referred to as equity bridge facilities and subscription line facilities or credits.
Experts at HML Solutions may use bridge loans to provide hopeful investors with the private equity financing necessary to continue moving forward. Our Florida-based organization offers many services and solutions with a deep understanding of current trends in the private equity market. We understand the need for flexibility and tracking as you work to improve the performance of your investments. In addition to helping investors, the loans may be used by institutions that need capital to cover short-term obligations. No matter how they are used or what they are called, bridge loans cover the gap between when you need the funds and when capital calls are made.
A Timely Solution for Significant Investments
Bridge loans have become a popular tool within the private equity world, especially over the past few years. According to the April 2021 Quarterly Update, inflation will be a focus for investors, and investors’ prospects will continue to brighten as inflation spurs interest in the asset class. With increased interest in significant investments, quick sources of convenient financing have become vital. Bridge loans have successfully provided funding gaps since before the turn of the century, and their use has grown steadily between then and now. Today, the loans are a key part of investment processes throughout Florida and other states.
These short-term loans are frequently used for real estate investments, both commercial and residential all over Florida. The loans are used by individuals, investment firms, and companies of all sizes. Some of the most common uses of the loans include the purchase of investments at an auction, the purchase of a rental property, the purchase of homes and properties for flipping, and the chance to relocate. Purchased properties may include condominiums, office buildings, warehousing properties, gas stations, retail centers, and hotels. Another important use of the loans includes getting cash out of existing properties and the built-up equity.
Benefits of Bridge Loans
There are several important reasons for the popularity of bridge loans, especially in recent years:
- Bridge loans are convenient and offer quick access to needed capital. This affects both flexibility and liquidity, two things that are vital within the investing and private equity sectors.
- The loans can be used to finance time-sensitive opportunities; qualifying and getting approval happens much more quickly than through traditional lenders.
- They offer funds when financial resources are allocated in other currencies.
- Credit scores don’t affect qualification or loan amounts as much as the value of the real estate.
- Properties that need a lot of work present difficulties for traditional lenders; bridge loans are an appropriate solution in these situations.
- Bridge loans provide the possibility of a delay of capital calls. This reduces the administrative load for investors and private equity funds.
Another important, albeit sometimes controversial, benefit of equity bridge financing is the inflation of returns. This happens when one partner’s equity is used for a shorter length of time, resulting in an increased internal rate of return. Thus, the measured performance of the equity reflects positively in investment criteria. The IRR also positively impacts the determination of carried interest.
Additionally, bridge loans are usually secured through a limited partnership, and they may not be considered when the investment fund’s leverage ratio is reviewed. This is important for private equity firms who want to keep their debt burden within a specific limit. The means of securing the loans means that the fund’s capacity for investments hasn’t increased.
Bridge Loans: A Non-Traditional Option
There are two basic types of lenders: traditional and non-traditional. Bankers are traditional lenders and look at expected factors:
- Amount of the loan
- The borrower’s credit history
- Cash flow estimate
- Available collateral
These factors are weighed to determine the lender’s risk, and if any of these factors are uncomfortable for the lender, Florida borrowers may struggle to obtain a traditional loan.
The good news is that there are alternatives available. Non-traditional loans come in many forms:
- Crowdfunding
- High-net-worth individuals
- Insurance funds
- Online lenders
- Pension funds
- Family offices
- Sovereign funds
Those lenders are often willing to offer non-traditional opportunities because private equity funds tend to be creditworthy ventures. Of all these alternatives to traditional loans, the bridge loan is uniquely suited to satisfy the needs of Florida borrowers.
Before offering a bridge loan, however, lenders carefully research the creditworthiness of the proposed investment opportunity. This research is primarily based on the strength of the fund and the fund investors. Lenders will also take the fund’s ability to call capital into account. For many lenders and prospective borrowers, interest rates are relatively low even for significant loans.
Florida borrowers should expect to present a solid credit history and demonstrate a secure position within the market when seeking a loan. It’s generally better for prospective borrowers to seek help when short-term credit is a viable solution, rather than waiting until the financial situation becomes desperate.
The Risks Faced by PE Funds and Investors
Naturally, there are certain risks and disadvantages involved with providing or taking bridge loans. As the popularity of the loan type has increased, so have the terms. Repayment terms may extend over a year, and this has an impact on the internal rate of return. While there are positive results from this, there are also some drawbacks, such as the incentivization of funds; the IRR may increase, but only as a result of time – not because the investments and related projects were profitable. This false sense of security can encourage the inappropriate use of credit lines.
The risk of investor default is another reason to carefully consider the loans before committing. Bridge loans decrease the risk and occurrence of capital calls, but also increase the risk that investors will default on those calls. This is, in part, because the capital call amount has increased even though the frequency of calls has decreased. For many Florida borrowers, this means that bridge loans are a more expensive route, with high interest rates, for obtaining financing.
Private equity funds aren’t required to submit information regarding the use of bridge loans, so there’s a lack of information. In fact, there’s a distinct and troubling shortage of data on the loans and the private equity funds’ performances, specifically when used during a recession. This absence of reliable information may make it difficult for lenders to accurately determine risk.
The lack of regulation and disclosure requirements has also made the use of bridge loans a bit uncertain.
Of course, some private equity funds have had negative experiences. In the past, strong companies have acquired financing through bridge loans to purchase investment opportunities, only to see the value of those investments take a steep drop before an appropriate amount of capital was raised. In these situations, the borrowers and lenders were both negatively impacted.
Those potential borrowers in Florida should thoroughly consider whether they can accept the terms (high interest rates, short loan length, and lack of information) before committing to the loan. Once the borrower fully understands and accepts the terms, bridge loans can be very beneficial. As with all other financing solutions, borrowers must carefully weigh the benefits and disadvantages before determining whether the solution is appropriate.
Industry Recommendations for the Use of Bridge Loans
The Institutional Limited Partners Association, a trade association in the private equity asset class, recommends that bridge loans are used to benefit both parties rather than simply for increasing the IRR. The ILPA published several recommendations about the best practices regarding the use of the loans:
- Loan lengths should be less than 180 days.
- No more than 20 percent of the funds should be committed.
- Lenders and funds should work on increasing the level of transparency in interactions.
- Consistency throughout the funds’ lifetimes should also be increased.
- Quarterly disclosures of information regarding the size, terms, and costs of the loans should be published.
The Future of Bridge Loans
Bridge loans are expected to maintain their popularity in the upcoming years based on consistent liquidity and the consistent emergence of non-traditional lenders. Florida borrowers, lenders, and industry leaders may watch the performance of bridge loans throughout the ups and downs of the market in the next few years. Hopefully, more information about the use of the loans will be shared by private equity funds.
Florida investors and business owners can use bridge loans as private equity financing for short-term solutions that save their businesses or make new opportunities possible. The loans are likely to provide convenient solutions and increased business stability as the loans are better understood and as more information becomes available. HML Solutions is committed to providing useful solutions to Florida business owners.