A small business or a start-up may be good with its business execution but it may still need small business loans regularly to meet its short-term requirements to grow steeply but steadily. There are various business finance options available for small businesses while choosing a business loan in India. New-age lenders and investors have made it easier for small firms to procure a business loan in India. Financing can come in the form of small business loans or an equity investment but an SME needs to carefully consider the total cost of capital and the conditions imposed by the lender / investor before making a credit decision.
Here is a quick look at factors you need to keep in mind when seeking a loan:
Risk assessment for small business loans
As a small business or a start-up, you have to keep in mind that a certain category of secured loan lenders such as banks may perceive you to be a high-risk customer to extend small business loans to, and therefore funding may prove to be more difficult to obtain. In the current economic scenario and with increasing non-performing assets (NPAs), banks are more cautious about where their money is going. So, while considering business finance applications, they may ask for guarantors, especially for those businesses that have no track record in repaying small business loans.
Also, if a business is perceived to be riskier, then the lender may seek a higher interest rate as compensation for taking the risk, thereby increasing the cost of a small business loan. The performance of the overall industry in which your business operates as well as the buying patterns and customer spending will be carefully analysed before assessing the level of risk.
You must always keep in mind the financial and business implications of seeking business finance. In case of unsecured loans, a lender cannot seize any assets of the business in case of non-payment. But defaulting on a loan can have serious consequences and the business might not be able to take another loan in future. Also, failure to meet repayment obligations could end in a lawsuit. However, before taking such dire measures, lenders are likely to offer options to make it easier for a business to repay the loan.
Business finance costs
Factor in all costs associated with small business loans before making the final decision. The most pertinent costs for loans for business in India include interest rates and processing fees. In case you take money from venture capitalists, you might not be required to pay for years. However, the same investor might want to be repaid at a steep premium in one go. You also need to consider the personal requirements each lender or investor insists on for business finance. Some of these may include your credit score, assets in place, debt-to-equity or interest coverage ratios. Therefore, discuss such requirements thoroughly with each lender before applying for business finance.
Business finance through venture capitalists
In case you have made up your mind to get business finance through investment, you are likely to incur other kinds of costs. Venture capitalists might initially want to pick up an ownership stake in your company and then expect you to buy back at a premium after a period of rapid growth. However, they may assert their right to influence management and would want to have a say in strategic decisions. You will have to provide them confidential information about your business as well as detailed explanations about your business decisions, something that you might be reluctant to do, considering the competition.
Therefore, owners who do not want to lose control over their business will only consider loan capital. Once the loan is paid back, your relationship with the lender ceases; but investors wield influence over the company until they are bought out or the company is sold. Thus, how you choose business finance also has an impact on your control over its management.
Tenure of the small business loan
The duration of business finance –whether long term or short term– depends on the type of business need. For instance, if you were to consider buying a piece of machinery that will be a part of your company for a long time, you could consider going in for a long-term loan. Needless to say, a long-term loan will have to be repaid over a longer period of time. On the other hand, short-term loans are obtained to meet business finance needs that are more urgent in nature and have to be addressed at a short notice. This is also true for business needs that are seasonal in nature and for money to cover day-to-day operations of a business. Such a loan has to be paid back in months rather than years. Overdrafts and supplier credits are examples of such kind of short-term loans. Moreover, interest rate movement also plays a critical part. For instance, if interest rates are high but appear to be moving southwards in the near future, it makes much more sense to take a short-term small business loan. Also, short-term financing does not come with any additional penalty for early payment, which is not the case with long-term finance.
Flexibility in the use of funds
Whenever you take an unsecured loan for business in India, the lender does not impose restrictions on how and where you can deploy these funds. The borrower is free to use the loan amount to fund daily operations, purchase raw materials, pay bills, salaries or even for marketing. In the case of a secured loan, the amount of loan that business can borrow is directly proportional to the value of the collateral but in unsecured business loans, the amount is determined by the business need. The key reason behind the popularity of unsecured business loans in India is their easy availability, with many FinTech lenders making it possible to disburse such loans in a matter of a few days through the use of technology.
In a nutshell, every type of business finance option has pros and cons but keeping the above factors in mind will help you take the right decision for your business needs.