Out of 190 countries, India’s ranking with regards to ease of doing business improved in 2018. It moved up by 23 positions, from 100 in 2017 to 77 in 2018. There have been a host of factors responsible for such a transition. These include ease of starting a business and access to credit. This is certainly a great achievement. but, there is still room for further improvement.
When it comes to disbursing loans to enterprises in India, the commercial banks and NBFCs have a tedious loan procedure. They have a detailed and challenging criteria for evaluation before extending business loans. Hence, as a business owner, you need to be apprised with
- factors considered for getting a loan for your small business and
- business loan documents that you require.
Therefore, to help you on how to apply for a business loan, here is a step by step guide. This includes everything, from the type of business loan you should apply for to the eligibility criteria to qualify for different loans.
I. Purpose of Business Loan
It’s a fact that if you are looking for a business loan, there are innumerable options that you can count on. These loan types are designed to cater to your fund requirements in varied situations. Hence, it’s important to first understand the purpose for which your business needs finance. Then you must search for options available for availing loan. Because it is then that you would understand which loan type suits your need perfectly.
Thus, it is imperative to understand the relationship between business loan purpose and loan type to be undertaken before assuming a business loan. This can be explained with the help of few examples.
Take E-tailers like Amazon and Flipkart. They are investing huge sums of money to make customers buy products at just a click of a button. Similarly, consider Digital wallet companies like Paytm. They have been raising funds to offer comprehensive payment services for customers and merchants. And lastly, ride-sharing companies like Ola and Uber. They have also been tremendously taking funding to transform and expand commuting services.
So all these companies are able to innovate and expand with the help of funds through different sources. One of the sources is certainly business loans with varied terms.
Meet Raven Textiles and Sharma Packers
Take the example of a company named M/s Raven Textiles. It requires funds for building a warehouse or buying an equipment. Now, consider another company by the name of Sharma Packers. It too needs funds for managing its cash flows. If we look at the cash requirements of both the companies, they are completely different from one another. So a short term working capital loan would not be able to meet M/s Raven Textiles’ requirements. This is because it is designed to finance the operating expenses of a business. Similarly, an equipment loan crafted to fund equipment, plant and machinery cannot cater to the requirement of Sharma Packers.
Hence, if you need a business loan, it is first important to understand the purpose behind taking such a loan. Once that purpose is clear, it will be easier to choose the right type of loan for your business needs.
II. Check for Type of Business Loans
Your small business needs financing for a variety of reasons. There are different types of business loans that are disbursed by commercial banks. These are according to the need, growth stage and nature of a particular business. Each loan type has its own qualification requirements, rate of interest and term of lending. Furthermore, each is crafted to cater to your specific business needs and help you plan disbursements accordingly. Broadly, there are 6 types of business loans that you can seek:
1. Term Loans
The term loans are secured loans offered to businesses for their expansion, capital expenditure and fixed assets. As the name suggests, these loans are provided in lump sum for a specific period of time and must be repaid in regular installments.
2. Line of Credit
Line of credit is basically an agreement between a financial institution and the borrower. Accordingly, the lender agrees to lend a maximum amount of money to the borrower depending upon his credit worthiness. Further, the interest is charged only on the amount borrowed. That means the amount that stands unutilized does not carry any interest.
3. Equipment Loans
Equipment financing refers to a loan used to purchase business-related equipment including computers, machinery, vehicles etc. Under such an arrangement, the borrower is required to provide periodic payments that include interest and principal over a fixed term. Furthermore, to secure the loan, the lender demands a lien on the equipment so financed as the collateral against your loan. Once you pay the loan in full, you own the equipment free of any lien.
4. Bank Overdraft
Bank credit is contemplated as a short-term credit that is provided by a financial institution to a borrower. This facility involves extending credit to a borrower when there are insufficient funds, that is when the account reaches zero. Simply put, a bank overdraft facility allows its customers to borrow a set amount of money on one’s account.
5. Working Capital Loan
Working Capital Loan is a short term loan that helps in financing the day-to-day operations of your business. Such operations can include managing payroll, paying rent, purchasing inventory, procuring raw material, maintaining cash etc.
III. Choose the Type of Business Lender
Every entrepreneur requires monetary support to carry out various business activities. Such a monetary support is required at every stage of the business cycle. Business needs finance at every phase. Be is starting a business, purchasing fixed assets or meeting operating expenses.
The amount of funds required by a business owner depends upon the nature and size of the business. Furthermore, timely and adequate supply of funds is fundamental for all types of business setups. That is, small, medium or large.
Therefore, to meet the financial needs of business owners, financial institutions in India have been set up. These have been broadly classified into different categories. Such a classification depends upon the nature of finance required by business owners. There are various types of lending institutions of the Indian financial system. These include banks, financial institutions, non-banking financial companies and venture capital companies.
1. Commercial Banks
Banks in India are classified into scheduled and non-scheduled banks. Scheduled banks are those that are included in the second schedule of the RBI Act, 1934. This schedule includes those banks which have a paid-up capital and reserves of an aggregate value of not less than Rs. 5 lakhs. Furthermore, such banks are engaged in affairs carried out in the interests of the depositors.
Non-scheduled banks, on the other hand, are the ones that have not been included in the second schedule of the Act.
Now, the scheduled banks are bifurcated into scheduled commercial banks and scheduled cooperative banks. Furthermore, the scheduled commercial banks in India are categorized into five different groups based on their ownership and nature of operation. These include:- (i) Nationalised Banks; (ii) State Bank of India and its associates; (iii) Regional Rural Banks (RRBs); (iv) Foreign banks; and (v) Other Indian private sector banks.
While, the Scheduled Co-operative Banks consist of Scheduled State Co-operative Banks and Scheduled Urban Co-operative Banks.
Currently, India has 170 scheduled commercial banks in total. Out of these, 91 are Regional Rural Banks, 19 are Nationalized Banks, 8 State Bank of India Branches and the Industrial Development Bank of India Limited (IDBI Ltd.) Additionally, there are non-scheduled commercial banks in the country.
Some of the nationalized banks in India include Punjab National Bank, Allahabad Bank, Bank of Baroda, Indian Bank and UCO Bank. Whereas major private banks include HDFC Bank, ICICI Bank, Axis Bank and Yes Bank. Furthermore, bank like Citibank, HSBC and Standard Chartered Bank are the foreign banks in India.
2. Non-Banking Financial Companies
NBFC is separate from a bank. It is a company registered under the Companies Act, 2013 that is engaged in the business of:
- Loans and advances
- Acquisition of securities issued by Government or local authority or other marketable securities of a like nature
- Insurance business
- Chit business
Such a company has the principal business of receiving deposits under any scheme or arrangement. And these deposits can be collected in one lump sum or in installments by way of contributions or in any other manner. By principal business we mean that an NBFC must have financial assets that are more than 50 per cent of the total assets. Furthermore, income from such financial assets must constitute more than 50 per cent of the gross income. Also, the minimum net owned fund of the company should be Rs 2 Crore.
Now what makes an NBFC separate from a bank is that it cannot accept demand deposits through savings and current accounts. That is, an NBFC can accept only term deposits. Furthermore, such a company does not form part of the Payment and Settlement Mechanism.
Depending upon the type of liability, size of an NBFC and the type of asset, there are different types of NBFCs. Few of the NBFCs in India include Magma Fincorp Limited, Fullerton India Credit Company Limited, Tata Capital Limited etc.
3. Angel Investors
Angel investors are wealthy individuals among an entrepreneurs family and friends who invest money in his company. Unlike venture capitalists, who invest other people’s money, angel investors invest their own money in a small startup or an entrepreneurial company. Such capital is injected in exchange for ownership equity or convertible debt. The objective behind investing money in a startup is to help the same in its initial phase rather than expecting profits.
There are a number of angel investors and platforms that are a part of Angel Investors India Network to help startups take their first steps. Few of them include the Indian Angel Network, Mumbai Angels and Let’s Venture.
4. Venture Capital
Venture Capital is a type of financing that investors provide to small businesses and startup companies that have high-growth potential in the long-run. The individuals who invest money into such high-growth potential companies are called venture capitalists. These venture capitalists are high networth individuals and institutional investors that pool in money through dedicated investment firms. Such an investment is made when a venture capitalist buys shares of the high-growth potential company and becomes a financial partner in the same.
This type of investment is also termed as risky investment as it involves risk of losing money. However, the potential of such an investment to give above-average returns is an attractive payoff. Few of the active venture capital firms in India include Accel Partners, Nexus Venture Partners, Kalaari Capital and Helion Venture Partners.
5. Government Funding and Schemes
To promote small and medium enterprises and encourage the growth of startups, the Government of India has introduced a wide array of schemes. Each of the schemes were launched to cater to specific financial needs of a small business enterprise or startups.
Some of government schemes for small scale industries and startups include:
- Credit Guarantee Scheme
- Credit Linked Capital Subsidy Scheme for Technology Upgradation
- MSME Market Development Scheme
- NewGen Innovation and Entrepreneurship Development Center
- Performance and Credit Rating Scheme
- Single Point Registration Scheme
- Infrastructure Development Scheme
- Aspire – Scheme for promotion of innovation, entrepreneurship and agro-industry
- National Awards
- International Cooperation Scheme
- Raw Material Assistance Scheme
- Atal Incubation Centers
- Bank Credit Facilitation Scheme
- Pradhan Mantri Mudra Yojana
- Stand Up India
- Startup Assistance Scheme
6. Financial Institutions
In order to provide adequate supply of credit to varied sectors, the Government of India has developed a structure of financial institutions in the country. These institutions are broadly categorized at two levels: All India Level and State Level.
National Level Institutions
The national level institutions provide long and medium term loans at reasonable rates of interest. They subscribe to the debenture issues of companies, underwrite public issue of shares, guarantee loans and deferred payments, etc.
The national level institutions include All India Development Banks (AIDBs), Specialized Financial Institutions (SFIs) and Investment Institutions.
AIDBs are development banks that provide institutional credit to only large and medium enterprises. Such banks also help in the promotion and development of small scale industrial units. IDBI, IFCI Ltd., SIDBI and IIBI are the development banks in India.
SFIs are the institutions that cater to the financial needs of trade and commerce in the field of venture capital, credit rating and leasing etc. IFCI Venture Funds Capital Ltd (IVCF), ICICI Venture Funds Ltd and Tourist Finance Corporation of India (TFCI).
Finally, investment institutions like LIC, UTI and GIC are the financial intermediaries that cater to the needs of small savers and investors. These institutions deploy their assets majorly in marketable securities.
State Level Institutions
The State Level institutions on the other hand deal with the development of medium and small scale enterprises. Though these institutions provide the same type of financial assistance as provided by the national level institutions.
These are established at the state level. These institutions promote investment and developmental activities in respective states.
IV. See if You Qualify For Business Loan
Before you approach any lender for loan, say a bank or an NBFC, it is always worthwhile to know its requirements. Knowing if you fulfill the criteria set by the financial institution before application of loan can save you on time and panic. Here are some things you should be prepared with before approaching financial institutions for business loan.
1. Credit Score
The first thing a lender will ask for when you apply for a business loan in India is your CIBIL Transunion Score. Credit Intelligence Bureau of India (CIBIL) is the first credit company of India. It collects and maintains records of all credit activities of individuals and corporate institutions, including credit cards and loans . All of the member institutions of CIBIL submit credit activity reports to the bureau. This bureau further uses this information to issue credit reports and issue credit scores.
So, What is a Credit Score?
Your credit score basically tells your lender the degree of credit risk (high, low or no credit risk) it would be exposed to, in case it decides to extend loan to you. It’s a three digit number that ranges between 300 – 900. Closer your score to the upper limit i.e. 900, more financially responsible you are deemed to be.A higher credit score gives confidence to financial institution about your loan repaying ability. A score above 750 is considered a good credit score. Anything about 800 is excellent.
Why is a Good Credit Score Necessary?
Needless to say, having a good credit score is an absolute necessity. This is because financial institutions get the confidence in your financial abilities and consequently your loan repaying ability. This makes them pass on certain benefits. These include higher loan amount, low interest rates, longer repayment period, faster loan approval etc to you
2. Lender’s Requirements
The minimum or the eligibility criteria for business loans varies from one financial institution to another. These also vary depending on
- the type of entity such as partnerships, limited liability companies etc and
- type of self – employed such as professionals and non – professionals.
But, there are some common requirements across lenders that you should be prepared for before hand. These include minimum:
- Annual Turnover
- Years of experience in current business
- Years of total business experience
- Number of years for which business is making profit
- Annual income and minimum and maximum age of the applicant
3. Business Plan
Lenders would want to understand the reasons for which you need credit. Also, they would want to understand how do you intend to spend such a credit. They would want a sound business plan that contains the purpose of your loan, the areas where your loan amount would be spent and your loan repaying capability.
There are certain components of a business plan that your plan must include. Some of them are:
- purpose for which you intend to take the loan,
- current and projected financial statements,
- areas where your loan amount would be spent and
- cash flows which are sufficient to meet your ongoing business expenses and repay loans.
A solid business plan that clearly defines such things, gives confidence to the lenders and helps in making the loan approval process faster.
Collateral is basically an asset such as inventory, land, property etc that can be held by lender in the event of non payment of loan. In order to avail a business loan, you need to provide collateral to your lender. Lenders usually ask for collateral to cover the risk of non – payment of loan amount in case of your business failure. There are certain loans that require sufficient collateral as a security plus a personal guarantee. When it comes to personal guarantee, the personal assets of the guarantor can be used by the lender in case of non – payment of business loans. There are lenders who may ask for a blanket lien. Blanket line is a type of collateral that authorizes the lender to dispose of your business assets to recover non – payment of the loan amount. In some cases, banks may not ask for a collateral. But may want a personal guarantee to back the loan amount. In case you do not want to go for loans that are backed by collateral, you can choose to apply for unsecured loans. Thus, every lender has its own terms and conditions to extend loan to business owners. And for this reason, you must consult the lender for collateral amount, before applying for a business loan.
5. Documents Required
Once you have considered the factors for business loan qualification and have fixed the existing issues if any, next step is to gather the required loan documents. Although these may slightly vary from one financial institution to another and the type of entity, here’s a broader list of documents you must keep handy.
1. Application Form
Availing a business loan starts with the application form. The financial institutions, via these application forms, want to know about who you are, the business you are into and the type of customers you deal with. Say if you approach a bank for a business loan, you could find following details to be filled in the application form:
- your business entity – name, legal status, year of incorporation, PAN number, Sales Registration Number, address, number of employees etc.
- contact person’s information – name, designation, mobile number etc
- management profile – directors/partners/proprietors information such as name, educational background, experience etc
- Shareholding Pattern in case of Public Ltd/Pvt Ltd/Ltd/and Partnership firm – names of shareholders, % share etc
- Business Profile – type of business, size etc
- Product Details – types of products etc
- Customer Information – list of customers, credit period etc
- Supplier Information – list of suppliers, credit period etc
- Current year Sales – sales of past 6 months
- Details of Banking Relationships – terms loans, working capital facilities availed from various banks etc
2. KYC Documents As Per RBI Guidelines For Applicant and Co – Applicant (if any)
To avoid fraudulent and money laundering activities, the government of India made it mandatory for financial institutions to formulate a Know Your Customer(KYC) Policy . These are basically the officially valid documents that establish the proof of identity of the applicants. A list of KYC documents required to be given by various entities are as follows:
1. Proof of Identification:
- Adhaar Card
- Voter’s ID Card
- Individual PAN Card
- Driver’s License
2. Proof of Address
- Utility bills such as electricity, broadband, telephone,
- trade license,
- rental agreement,
- GST Certificate
3. Documents for Financial Checks
Your business’s bank statements, generally for preceding two years
4. Documents for Tax Compliance
- Latest Income Tax Returns duly certified by CA
- Income Statements and Balance Sheets of last 2 years audited by CA
5. Proof of Continuation
Vintage proof or continuation proof which includes
- Income Tax Return
- Registration Certificate
- Trade License
- Sales Tax Certificate
Depending on the type of business you own, the bank will also require one of the following:
- Sole proprietor declaration or a certified copy of your partnership deed
- Certified true copy of Memorandum and Articles of Association that’s certified by the director
- An original board resolution document
6. Other Important Documents
These can include Memorandum of Association, declaration of ownership, Resolutions, Power of Attorney or any other documents required by the lender.