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.
For a growing business, 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 be a partnership buy-out just to name a few.
Alternatively, a series of unforeseen adverse events has constrained cash flow and pressure is mounting with creditors and financial commitments. Short term liquidity is required to trade through these issues and to buy time to perhaps restructure the business to become more streamlined and profitable. The cost of additional credit stands second to the importance of accessing credit, for without it the downside consequences potentially becomes far more adverse.
Two key resources are required when events like this generally occur. You need to move quickly, and you need access to capital.
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 flipside to this point, the bank may have the capacity to (eventually) fund the proposal, but the due diligence timeline does not allow this proposal in a manner that secures the opportunity or meets the required timeline. 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 funds, the purpose and execution of funds deployed, the security, and the exit.
Bridging finance may have more flexible structures to meet the borrower’s circumstances. The interest may be capitalised throughout the term of the loan to allow the execution of the strategy to 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 be available with the major banks for the 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 of accessing the capital vs the additional cost or opportunity cost of not accessing the capital. Noting that the bridging finance is just a temporary position within a business timeline that may extend decades, 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 future 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.
Case Study: $5.0m
A client was in a unique situation where they had strong non-traditional greenfield development plans for some of their assets which involved an infusion of capital to capture the opportunity. These assets were not generating sufficient cash flow for a major bank to support the proposal and the exit was deemed speculative under normal bank policy. In addition, the security being offered was agricultural land which is an asset class that is not considered mainstream and well understood.
Robinson Sewell Partners secured private funding to refinance the existing mainstream bank plus provide an additional $2.5m so the client could execute their strategy.
Loan Amount: $5.0m
Term: 11 months interest only. Rollover option available
Establishment Fee: 1.0%
Interest Rate: 9.00% p.a.
Exit Strategy: Refinance or consolidation of one asset.
Debt capital beyond the realm of traditional banking can open a multitude of opportunities for businesses to expand with significant funding restrictions. With bridging finance, the sponsor, funding purpose, security provided, and the exit strategy are the key areas for management to control. The rest is around good financial structuring to ensure the project is fully funded from the onset to ensure the journey from “A” to “B” is not financially restrained. If the long-term economic benefits vs risk vs short term cost of capital is positive, then the venture is worthy of serious consideration.
Jeff and Paul had a recent meeting with Ian Robinson of Robinson Sewell Partners and recommend anyone seeking further information on this topic reach out to him:
0448 697 674