Bank Finance

The Union Budget 2015 has recognised the importance of micro, small and medium enterprises (MSMEs) as the backbone of the Indian economy and the engine of growth and employment. While it put the infrastructure sector under the spotlight by promising to pump in additional funds, it also gave the IT and technology sectors a major push with a Rs 1,000-crore fund for self-employment and talent utilisation. The news has been encouraging for MSMEs in general and entrepreneurship in particular.

Financing is necessary at every stage of a business life cycle. It is required to help startup to set up and expand their operations, and to develop new products/services. India has a well developed financial system, comprising banks, financial institutions, non banking financial companies and also venture capital companies. All these institutions cater to the diverse financial needs of the Startups as well as existing businesses. Various schemes are being implemented by various banks and financial institutions to cater to the financing needs of the Micro, Small & Medium sized businesses.

Securing funds for a startup is one of the toughest challenges an Entrepreneur faces while starting a new business. With a plethora of funding options available, it is important for the Entrepreneur to understand the pros and cons of each funding methodology, estimate the amount of funds required, the application of funds, projected financial position of the business including the returns generated and evolve a strategy – to approach and secure the required funds. With venture capital firms and angel investors enjoying plenty of coverage as a great source of funding for startup, many Entrepreneurs are unaware that financial institutions and Banks are also an avenue of funding for startups. In fact, Banks are one of the largest funders of startups in India, providing funding to thousand of startups each year.

Banks and financial institutions provide financial assistance for companies all stages of the business lifecycle. Startup companies can avail a host of term loan or working capital or asset backed loans based on their requirements. Banks will lend even to a start, if they are satisfied with the business model, projected returns from the business, the ability to pay back the loan (through business or otherwise), management experience and expertise and other security provided.

Many banks and financial institutions offer schemes aimed at startups. For instance, SIDBI offers “Growth Capital & Equity Assistance” for SMEs that require capital for growth. The funds from SIDBIs “Growth Capital & Equity Assistance” scheme can be used for marketing, brand building, creation of distribution network, technical know-how, R&D and software purchase.

SIDBI also offers the SIDBI Revolving Fund for Technology Innovation-(SRIJAN Scheme) which provides financial assistance to MSMEs towards development, up scaling, demonstration and commercialization of innovative technology based projects. The assistance is given in the form of early stage “debt” funding on softer terms for development, demonstration and commercialization of new innovations in emerging technological areas, un-proven technologies, new products, process, etc. which have not been successfully commercialized so far. Maximum assistance is generally not more than Rs. 1 crore per project. Interest rate would be as approved by the Project Approval Committee (PAC) (not be more than 5% p.a.).

Prior to approaching a banker or an investor with request for funding, the promoters of the business must first prepare a pitch that explains the business model, promoters background, revenue model, estimated sales, estimated profit, estimated growth rate and returns. Return on investment is a key factor for both banks and equity investors. Therefore, it is important for the promoters to gather, familiarize and compile the information in a presentable format first (could be a Detailed Project Report). Once the investment pitch is ready, the promoters must identify potential banks that have schemes or the facility for providing the requested funding. It is important for the promoters to structure their request in a way it would fit into the framework of RBI’s and Banks lending policy, i.e. not requesting funds for marketing at an institution that provides only term loans. Once, the above two steps are complete, they can approach the bankers, present the pitch and request for funding.

As per author there are various benefits if a startup can get a bank loan instead of a venture capital in the startup stages.

1) Venture capital funds are very costly with VC investors expecting 5-10 times return on their investment. However, bank loans do not require equity dilution and the rate of return to the bank is fixed at a nominal amount of about 13-17%.

2) Banks are easier to approach. With banks available everywhere in India, it is easier to approach your local banker and request for funds that meeting a Venture Capitalist or Angel Investor.

3) Established framework for funding evaluation. Banks have a well structured framework for processing funding request. Therefore, an answer to your request for funding will be processed more quickly than when compared to a venture capitalist or angel investor.

4) The profits/loss of your business belongs only to you.

Medium and long term loans required for setting up projects can be obtained from banks and \or financial instituitions for all viable projects. Similarly, funds required for modernisation and renovation schemes can be borrowed from them. Such loans are generally secured by mortgage of the Company’s properties, pledge of shares, personal guarantees etc..

To access details on various credit schemes of commercial banks in India, click here

To access details on various forms of commercial banks in India, click here
Bank’s Lending Criteria

Banks and other lenders tend to set their own internal rules. Nevertheless, all financial institutions are bound by general regulations and guidelines established by their national financial authorities (for instance, the central bank). There is usually a lending limit per customer: in many countries this is fixed at 25% of the institution’s shareholders’ funds. Also, as a general rule, lenders may not exceed a certain percentage of their credit portfolio (deposits from customers plus borrowings). This percentage is often around 75%. Banks may sometimes invoke their lending criteria or statutory regulations as a pretext for not granting a facility to a borrower. There is nothing much you can do about this and, in any case, it is un-wise to insist on borrowing from an unwilling lender. Your request for short-term credit will have greater chances of success if you can satisfy the lending criteria set out below:

Good Cash Flow: As a borrower, you must show that your performance is positive and that operation are not only profitable but also generate sufficient cash to cover all commitments.

Adequate Shareholders’ Funds: In other words, you must not be already over-committed to other lenders, but have a reasonable proportion of your own capital in the business.

Adequate Security: You will not obtain credit from a bank if all your assets are already pledged to other lenders.

Experience in Trading: Most institution likes to know that you have a good record of successful trading. It is difficult to convince a banker to lend you money if you are complete beginner, or if you are starting a completely new trading activity with untried products and unknown customers or suppliers in countries you have never dealt with before.

Good Reputation: Your references and credentials must be acceptable to lenders. They would no doubt find it difficult to convince their loans committee or board to approve an advance to a bankrupt company or a known crook! But, even assuming that your past is without blemish, it is helpful to have the backing of a reputable sponsor. This could be a well-known person in business, your trade association or even your customer or supplier.

Specific Purpose: Although some lenders grant overdraft facilities on the basis of the security you offer, most institutions prefer to link their loans to specific transactions. Transactions must be explained in full detail and shown to be profitable and self-liquidating (money borrowed will be repaid from proceed of transactions to be financed).

Rating Parameters: The lenders (Banks/ Venture Capitalists, etc.) carefully assess your credit worthiness and assign ratings by analyzing your business information with respect to various parameters. The main parameters that are generally used to rate business entities are provided below:

Management: Some of the key parameters considered include:

— Background

— Industry experience and knowledge

— Past conduct of borrower with banks

— Qualifications

— Background and Capability of the Promotors

— Organisation’s Preparedness for meeting Challenges

— Combined net worth of promoters

— Associate concerns

Financial: Some of the key parameters considered include:

— Current ratio

—Debt equity ratio

— Average turnover

— Net profits

— Income growth

— Net cash accruals

— Financial Projects and Debt Servicing Capabilities

— Provision of security for proposed assistance

— Quality of collateral security

 Operational: Some of the key parameters considered include:

— Proximity to branch

— Location of unit

— Borrowers proximity to market

— Type of technology

— Equipment supplier

— Quality certifications

Industry: Some of the key parameters considered include:

— Nature of industry – cyclical/ seasonal

— Eligibility under assistance scheme, if any

— Competitive advantage

— Branding of product

— Number of applications of product/ machinery

 Past Loan Performance: Some of the key parameters considered include:

— Re-payment history

— Missed installments

— Revision in interest rates/ period

— Prepayments

— Defaults: Month of default, Amount of default, Reason of default, if provided, Security re-sale value, Capital loss to bank

Preparing The Bank Loan Application: Banks would also like to ensure that your proposal meets all the necessary requirements for their internal sanction process. In order to minimise the time taken for these processes, it is wise to prepare the application form as early as possible. Attached herewith are a few sample application forms for you to look at. Please select a Form which fits your needs and start working on it. This will help you get a headstart and will possibly save some hassles at a later stage.

You can download Bank Loan Forms from here

Presenting Your Request:The way you approach a bank or other lending institution is all-important. Here are a few tips. Most are simply common-sense ideas, and you should always be guided by the elementary rules of courtesy and openness.

Know With Whom You are Dealing: Unless you are already one of the institution’s customers and know it well, find out all you can about the institution beforehand. Seek advice from your trade association, chamber of commerce, or local confederation of industry. Try to obtain a copy of the institution’s annual report land review its affiliations, shareholders and directors. Brochures and annual reports, normally freely available in banks and other institutions, tell you a great deal about their structure, organization and services. Banks should also indicate their lending rates and give you a schedule of their charges and fees for services.

Give Prior Notice of Your Intentions: Call beforehand for an appointment or, write a letter or a fax setting out briefly who you are and what you do, how much you need, to borrow and why. Although you can conduct your transactions by correspondence, it is usually preferable to meet the person in charge of short-term commercial lending or trade finance. If the institution is far away, this will obviously not be possible, in which case you should be particularly careful about how you introduce yourself and what information you provide.

Be Well Prepared: Your banker is a busy person and needs to know rapidly the nature of your request: you should come quickly to the point. State who you are, your line of business, how much money you need and for what you need it. Be prepared, to provide your annual report (if you produce one) or your financial statements (balance sheet, profit-and-loss account, budget, business plan), as well as a company brochure. State clearly what you intend to do with the funds you want to borrow. If your intention is to finance the purchase of goods or essential for manufacturing products for export (or the purchase of commodities from producers for export), tell your banker the whole story: from whom you are buying, to whom you are’ selling, how, you intend to pay and get paid. Speak to your bank about these matters before you sign contracts or agreements with your suppliers and customers or make payment arrangements.

Seek Advice: Experienced bankers can guide you and advise you on risks of various payment methods, on suitable ways to finance transactions and on the security you should provide as a guarantee for your borrowings. Remember to ask about hedging possibilities to cover or reduce risks of currency and price fluctuations.

Be Cautious: Resist borrowing more than you need, for too long, or at too high an interest rate. Banks sometimes propose the types of credits or payment methods with which they are most familiar, which are most remunerative, or which present the least risk. Ask about costs. Remember there are costs, fees and charges in addition to the interest rate. What about front-end fees? (These are payments deducted from the loan at disbursement to cover the lenders cost of evaluating your request, assessing the risk or opening the loan account.) What are the back-office fees? On each disbursement, for instance? If the advance is applied by the bank to purchase foreign exchange or to open a documentary credit, how much will it cost? Most institutions have standard or sliding-scale rates for their services. Never hesitate to ask for a copy and seek guidance on how these rates will affect your transaction. If there are to be legal costs, such as lawyer’s fees for drafting a loan contract or registering a charge on assets or a debenture, obtain clarification before committing yourself.

Avoid “Shopping Around”: Bankers will not like the idea of your shopping around for the best deal, visiting several institutions and making comparisons. If you say you have found a better deal elsewhere after they have spent hours with you, drawn up documentation and obtained clearance from their loans committee, senior management or board, you have wasted their time. There is, in fact, nothing wrong in trying to get to know the banking sector and wanting the best deal. But you should not give the impression that you are also talking to others after negotiations have reached the stage where the agreement is virtually finalized and awaiting management or board approval. The success of a good borrower-lender relationship is built largely on trust. A banker will often prefer to tryout a prospective customer by offering small, well-secured loans on a very short-term basis to see how it works. As transactions are successfully repeated, the customer’s standing rises and his or her credit improves. When you approach an institution for the first time, bear this in mind. The cheapest lender may not, in the long run, prove the best. For more detail click here