While starting a new business, one of the toughest challenges an entrepreneur faces is securing funds for a startup. With a plenty of funding options available out there, it is essential for an 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 evolving a strategy to approach and secure the required amount of funds.
With venture capital firms and angel investors enjoying a lot of coverage as a great source of funding for startups.
Many entrepreneurs are unaware that financial institutions and banking companies are also an avenue for generating funds for startups. In fact, banks are one of the largest funders of startups in India nowadays, providing funding to a thousand startups every year. In this article, we are going to cover the types of funding options available from banks as loans along with other questions surrounding bank loan for a startup business in India.
Do banks & financial institutions provide loans for a startup business?
Yes, banks and financial institutions provide financial assistance to companies for all stages of the business life cycle. Startup companies can avail a host of term loans or working capital or asset-backed loans based on their fund requirements.
Banks will lend even to a new budding company, 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/mortgage provided.
Do banks provide loans for startups in novel areas?
For companies starting up in novel areas where the business models have not yet been established, banks will ask for higher collateral security coverage typically with other source or backup sources of income. If the same can be provided by the borrower party, banks will lend to that startup with novel business models as well.
Can startups get a bank loan for research and development of technology in business?
Yes, it is possible to obtain a bank loan for research and development of any technology that has a prospective use in business or otherwise from banks. Asset-backed loans can be used for developing new technology or improving the existing technology or marketing or other business expansion efforts and goals.
Asset-backed loans are usually provided based on the market value of a residential, commercial or industrial property that is to be pledged/mortgaged. Banks lend up to 70 percent of the assessed market value of the property/asset with a loan tenure of seven to fifteen years.
Besides, the collateral security offered, the promoters will have to display to the banker the financial returns expected from the business operations and source of finance for meeting the interest of loan and the principle commitment on time.
Can startups get a bank loan for buying equipment or machinery?
Yes, a startup can definitely obtain a term loan from banks for buying equipment or machinery. Banks are pretty favorable towards extending loans for purchase, erection, and commissions of capital assets such as machinery and equipment to be used in the business.
Can a startup obtain a bank loan for stocking inventory?
Yes, a startup can also obtain a working capital loan from banks for stocking inventory or providing credit to the customers of the business but banks will assess the working capital requirement of a business based on the projection provided and will take a conservative approach to lend working capital funds to the business startup.
Can startups get a bank loan without offering any collateral security?
The Credit Guarantee Fund Trust Scheme for Micro, Small and Medium Enterprises (CGTMSE Scheme) provides a framework for the banks to extend up to 1 crore INR of a loan without any collateral security toward term loan and working capital requirements of a business but NOT for the purposes of marketing or technology development.
Hence, startups that require capital assets or inventory can utilize the Credit Guarantee Fund Trust Scheme for Micro, Small and Medium Enterprises to get collateral free loans from banks.
Loans under the CGTMSE scheme are provided by the banks on a very selective basis and only to very deserving entrepreneurs who exhibit very good financial and managerial acumen. Hence you can say that only a very few startups obtain funding from banks under the CGTMSE scheme to start their business operations.
Are there any specific loans or schemes for startup businesses?
Yes, many banks and financial institutions offer schemes aimed at startup businesses. For example, Small Industries Development Bank of India (SIDBI) offers “Growth Capital & Equity Assistance” for Small and Medium-sized Enterprises that require capital for the purpose of growth.
The funds from SIDBI’s “Growth Capital & Equity Assistance” scheme can be used for marketing, brand building, the creation of a distribution network, technical know-how, Research and Development and software purchase.
SIDBI also offers the SIDBI Revolving Fund for Technology Innovation (SRIJAN Scheme) which offers financial assistance to Micro, small and medium-sized Enterprises towards development, upscaling, demonstration and commercialization of innovative technology-based projects of the business enterprise.
The financial assistance is given in the form of early stage “debt” funding on softer conditions for development, demonstration and commercialization of new innovations in the emerging technological areas, unproven technologies, new products and process, and so on. Maximum assistance usually does not go up more than 1 crore INR per project.
The rate of interest would be as approved by the Project Approval Committee (PAC) and still, it will not be more than 5 percent per annum.
How should a startup approach a bank for obtaining funds?
Before approaching a banker or an investor with a request for funding, the promoters of the business must first prepare a pitch that explains the business model, the background of promoters, revenue model of the business, estimated sales, estimated profits, estimated growth rate and returns.
Return on investment is a key factor for both banks and equity investors and hence it is essential for the promoters to gather, familiarize and compile the information in a presentable format first which 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 to the business like theirs. It is necessary for the promoters to structure their request in a way that it would fit into the framework of Reserve Bank of India’s and banks’ lending policy, which means not requesting funds for marketing at an institution/bank that provides only term loans.
Once, the above two steps are completed, the promoters can approach the bankers, present the investment pitch and request for the required funding.
What are the benefits of securing a bank loan for a business startup?
There are various benefits if a startup can get a bank loan instead of a venture capital in the startup stages which are listed as follows:
- VC funds are a bit costly with VC investors expecting five to ten times return on their investment. On the other hand, 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 percent.
- Banks are much easier to approach than VC investors. With banks omnipresent in India, it is pretty easier to approach your local banker and request for the required funds that meeting a Venture Capitalist or Angel Investor.
- Established a framework for funding evaluation. Banks have a well-structured framework for processing the funding requests and hence, an answer to your request for funding will the processed more quickly than a venture capitalist or an angel investor.
- The profits earned or losses incurred of your business belongs only to you.