Even as loan processing gets easier and faster, small businesses continue to struggle for the much-needed finance for working capital and other business needs. One question that every MSME entrepreneur asks is who to approach for a loan.
FinanSME looks at the various options and the pros and cons of each.
What Are The Options?
Small business owners need finance at every stage of their business, and it is available from one of six sources:
- Owner’s Capital – Utilising the savings of the business owner
- Social Sources – Borrowing money from family or friends
- Private Lenders – Individuals who lend money to businesses at a personal level
- Crowd Funding – Requesting several people to invest a fixed small amount of money for a particular purpose
- Trade Credit – Requesting suppliers to sell on credit
- Financial Institutions – Borrowing from banks and NBFCs
- Owner’s Capital
Entrepreneurs use their savings to set up a business because others would be reluctant to invest. The most obvious benefit is that funding is readily available at low cost. Also, you know at the outset how much finance is available, which makes planning and budgeting easier. Besides, you can save a lot of time and effort, not to mention expenses, which you would otherwise incur in approaching various lenders and pitching your business model to them.
However, using your personal savings can result in adversity if you are unable to sustain. Failure can cost you more than your contingency fund and even result in bankruptcy.
- Social Sources
When the owner is unable to fund the business himself, he may turn to family and friends. This may seem like a simple and flexible alternative since you can tap the source at any time. However, there is a downside to it.
If you are unable to provide reasonable ROI to those you borrow from, they will be hesitant to lend again. Also, since such informal borrowing involves little or no documentation, the lenders may assume rights they do not have.
- Private Lenders
This may seem like the answer to all your financial woes since it mitigates the risks of both personal and social funding. However, most private lenders request collateral, the value of which may far exceed the amount of the loan. Also, in the event you are unable to repay the loan, you may lose your asset entirely. Moreover, the interest charged by the so-called “loan sharks” is considerably higher than other sources. With no formal agreement in place, there are many grey areas in terms of the contract under the eventualities of which the lender may foreclose, and other aspects of the loan agreement.
The risk of borrowing from private lenders is, therefore, extremely high.
- Crowd Funding
This is a relatively new concept where the borrower requests the general public to invest a certain fixed amount of money in their business. Since the amount is small and the channels of communication are many, it is relatively easy to obtain finance.
On the flip side, however, you have a large number of lenders, each of whom expects a small return on his investment. A crowdfunding campaign can be expensive to launch and maintain- you will have to share your business model and immediate strategy for the specific venture with your investors – usually on a public portal – which can be detrimental in the long run. Besides, crowdfunding can tie your hands to the extent of promises you make to your lenders. This type of financing has yet to take hold in India although it is gaining popularity elsewhere.
- Trade Credit
Trade credit is the credit extended by your suppliers. You can use the money you retain as a result of supplier credit to fund your business. This type of funding works best for working capital needs since it reduces your own capital outlay. However, you may have to purchase material at a slightly higher rate than the market value. Do note that the vendors may call in the credit at any time.
- Banks and NBFCs
Banks and non-banking financial institutions (NBFCs) offer loans subject to certain – usually rigid – terms and conditions. The most significant drawbacks of such lending institutions are:
- The interest rate is higher than most private sources.
- Processing and disbursement can take a long time.
- There are rigid rules and conditions for offering a loan.
- These institutions dig deep into the creditworthiness of the borrower, and not all may measure up.
- Institutions may insist on collateral.
While these are the risk factors propagated against lending institutions, they may be viewed as benefits too. The rigid rules and background check, for instance, serve to ensure the creditworthiness of the individual borrowers, not just for the concerned institution but for others – including creditors – as well. The well-established process and terms are in fact beneficial as borrowers are less likely to be duped into losing the assets offered as collateral. Also, there is no impact on social relationships. In fact, social standing can greatly improve for those borrowers with high credit scores.
While the sources of finance are many, it is best to borrow from a non-personal and well-established source. Banks and NBFCs fit the bill to perfection.
Today, access to Finance along with structured & lengthy documentation continues to be among the top challenges amongst others for SMEs as they struggle to meet their growth and operational requirements, and that’s where we come in!
In order to ease the pressures on cash flow and facilitate smooth running of business, Power2SME’s lending arm FinanSME helps provide Purchase Bill finance facility to its partner SMEs. Our Purchase Bill Finance facility infuses additional cash flow and gets you credit at a highly competitive rate of interest.
To learn more, write to us at firstname.lastname@example.org.