Intro to status-quo:
Small and Medium-sized businesses have a unique and unorganized ecosystem compared to the larger corporations in India. And hence there is a lot of information asymmetry, especially financial information like funding and government aid are usually lesser known amongst SMB entrepreneurs. This lack of financial awareness can put an SMB at risk of failure.
Why is this knowledge imp?
The lending gap in the MSME sector is roughly about 20-25 trillion INR as of 2019 according to the UK Sinha committee and this indicates the competitiveness of the space. Access to capital is a key challenge for entrepreneurs at this scale due to various restrictions and due diligence needed for different modes of funding. Having the knowledge about the right kind of funding and how to access it at different stages of the life-cycle (start-up stage, survival stage, growth stage, and sustenance stage) also becomes important.
Types of funding for SMBs:
Here are some of the sources of funding utilized by many SMB entrepreneurs, ranked from the easiest to least easy to obtain based on the need for collateral:
1. Personal Savings: This is one of the initial sources resorted to by most business owners in order to avoid taking debt. But there are two issues with this – (a) the level of personal savings and (b) how much of this savings you are willing to risk.
Usually, it’s a better idea to opt for other sources of funding in order to avoid putting personal funds at risk.
2. Family & Friends: Although a little tricky given the subjective nature of the relationships, obtaining credit from friends and family is an almost collateral-free way for funding. Sometimes it might involve an equity exchange as well so it’s important to be cognizant of the potential risk not just financially but also at a relationship level.
3. Crowd Funding: Obtaining funding from multiple smaller lenders through various crowdsourcing platforms works well for an innovative product. This might or might not involve returning the capital depending on the platform used. This mode does not require any collateral but needs immense trust in the product in the community.
4. Non-Banking Financial Institutions (NBFCs): Since they are not as regulated as the banks, the eligibility criteria are more relaxed leading to easier loan approvals. However, they do charge higher interest rates than those banks based on the credit score and risk profile of the borrower.
5. Government Grants & Schemes: Pradhan Mantri Mudra Yojana is a scheme for offering finance to MSMEs and has different funding amounts starting from Rs. 50,000 to Rs. 10 Lakhs depending on the stage of the company. These loans are easier to obtain since they don’t require any collateral for security. There are also others like Credit Guarantee fund Trust for MSEs (CGTMSE) and Emergency Credit Line Guarantee Scheme (ECLGS).
6. Business loans from banks:
a. Public and private sector banks – both these sets of banks offer business loans against collateral and strong credit history documentation. This slightly reduces the interest burden on entrepreneurs who maintain a good credit score.
b. Cooperative banks – given the flexible payment cycles and collateral needs, these are more preferred for smaller amounts of business loans
7. Angel Investors – Networking is a great way to find these wealthy individuals/families who are keen on investing in growing businesses, and this might also include losing out on equity in the business in some cases
8. Venture Capital firms – They are more suitable for medium-sized businesses looking for growth with a valuation target of 100 M$ within 5 years. However, there are some exceptions to this based on philanthropic endeavors so one should keep an eye open.
Conclusion:
It is imperative for the SMB entrepreneur to do his/her research and set financial goals upfront in-order to choose the right source of capital. Choosing an unsuitable type of credit line can lead to unwanted outcomes such as disagreements between the lender and business owner, waste of time and resources, the shift of control, and other negative consequences.
We at CSL finance help small and medium business enterprises with various funding needs. Do reach out for expert advice so that you can take the right decision at the right time.
Sources:
· https://www.paisabazaar.com/business-loan/small-businesses-can-use-business-funding-raising-capital/
· Alternative lending options than banks ( not India) - https://www.businessnewsdaily.com/1733-small-business-financing-options-.html
· Bank loans and process - https://www.creditmantri.com/small-and-medium-sized-enterprises-loans/
· Global MSME work done by world bank on finance gap - https://www.worldbank.org/en/topic/smefinance
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