How start-ups can use bridging and mezzanine finance effectively

Bridging finance has become a very popular way for individuals and businesses to raise money in the UK. The amount lent out through bridging in 2011 was £750m and this has increased five-fold to £4 billion in 2016, explains Octagon Capital.

Bridging finance is a type of short term finance appeals to the high-risk and high-return nature of startups and it can allow business owners to get the funds they need to capitalize on a business opportunity.

What is a bridging loan?

Companies apply for a bridging loan as a way to ‘bridge the gap’ between the purchase of something that has a strict deadline. It is a way to get a quick injection of cash and capitalize on an opportunity that you could lose because it is time sensitive. Once you have used the finance and generated significant income through sales or an exit strategy, you can then find yourself in a better position to repay the loan.

Loans are always secured on the property, offices or a business so if the borrower fails to keep up with repayments, their security is at risk of repossession.

Example: Business XYZ is a start-up growing very fast and they need to borrow large sum in order to meet their orders, take on new premises and hire more staff. By borrowing £200,000 through a bridging loan, they are able to take on new employees and meet customer demand by securing the loan on their new bigger office. Six months later, they make over £1 million revenue through their recent investment. They repay their bridging loan and find themselves in a strong financial position.

What is mezzanine finance?

Similar to bridging, mezzanine finance is better used for high-risk business opportunities. Whilst bridging is a type of secured loan, mezzanine is part loan, part equity in the business.

It can be ideal for start-ups that are so high risk that the lender does not feel that they have enough security, unless they get a small equity in the business. So for the lender’s point of view, they hope that the company really takes off and they get a bigger piece of the pot. It can also be used to top-up an existing loan so if the borrower needs more, they can receive but if they give up equity in their business.

Example: Start-up ABC needs £1 million to launch their new tech product. The mezzanine lender sees this as too risky an investment but the company do have an office which can be used as collateral. To make it work, the lender offers 70% of the money they need and takes 30% equity in the business to help the company achieve their goal.

Terms of the loan

The cost of bridging finance usually consists of monthly interest rates and arrangement fees. The amount you pay will depend on the lender’s rates, the value of your collateral, property price forecasts and the borrower’s credit rating.

Lenders will typically compound the interest into one large repayment at the end of the loan term. This is because the end of the agreement is usually when you should have enough to repay either because you have sold your property for more than you bought it or generated more revenue through your business.