A bank loan is an excellent option for many entrepreneurs starting a business in traditional areas such as service, manufacturing, and trading. While there has been growing interest in angel or private equity funding in recent years, bank loans continue to fund the largest number of businesses in India. With a strong banking system and a network of lending Non-Banking Financial Companies (NBFCs), entrepreneurs can easily obtain a business loan for a startup.
Scheme or Product Fit
Unlike equity funding, banks have a strong structure and mechanism for approving or rejecting loan sanctions based on various parameters. Therefore, before applying for a business loan, entrepreneurs must familiarise themselves with the schemes available at the bank for business loans and apply for the right one. For instance, many banks operate the MUDRA Loan Scheme, which provides unsecured business loans of less than Rs. 10 lakhs for new entrepreneurs. A new entrepreneur applying under such a scheme is more likely to have a higher chance of success compared to applying for a scheme where they do not meet the bank's lending criteria.
Documents
Bankers follow specific procedures while processing loan applications and require certain documents. To be considered for a bank loan, the entrepreneur must compile and submit the necessary documentation. The following are some of the documents required for processing a business loan application:
• Financial Projection
• Financials presented in CMA Format (Credit Monitoring Arrangement)
• Business Loan Request Letter
• Certificate of Incorporation (If Company/LLP)
• Partnership Deed (In case of Partnership Firm)
• PAN of the Promoters/Directors/Partners
• Address Proof of the Promoters/Directors/Partners
• MSME/Udyog Aadhaar Registration (if available)
• VAT Registration/Service Tax Registration
• Copies of IT Returns of the Promoters (if available)
• Bank Statement of the Promoters
• Valuation of Collateral Property (if applicable)
• Legal Opinion for Collateral Property (if applicable)
• Assets & Liabilities Statement of Promoters (if applicable)
The above list is indicative only. The banker, at their discretion, may request more or fewer documents based on the loan applicant's credit profile. Additionally, submission of the above documents does not guarantee the loan's sanction. The banker will assess the application's creditworthiness based on various factors.
Eligibility Criteria for a Business Loan
The following sections specify the eligibility for business loan
Profit & Cash Flow
Unlike angel or equity investors, bankers look for profit and positive cash flow when lending. Since bankers do not receive equity in the company, they are only entitled to interest on the funds loaned. Hence, they typically do not consider long-term profitability or projected positive cash flow in the future. Bankers prefer to fund businesses that show profitability and positive cash flow after the initial setting-up period. As a borrower, you must demonstrate that the business is performing well, operations are profitable, and you generate sufficient cash to cover all financial commitments.
Promoter's Contribution or Margin
To avail of any loan, the promoter must have funds to meet the promoter's contribution or margin. Banks do not lend 100% of the required funds for equipment or working capital investment. The promoter must contribute to the margin requirement stipulated in the loan conditions. For example, if an entrepreneur wants to purchase machinery worth Rs. 10 lakhs, the bank would sanction an equipment loan with a margin of 20% (assumed). In this case, the bank would provide a loan of Rs. 8 lakhs, and the promoter would need to invest Rs. 2 lakhs of their own funds to purchase the machinery. Depending on the loan type and entrepreneur's requirements, the margin requirement may vary from 50% to 10%.
Primary Security
Most business loan schemes provided by banks require primary security to be created from the funds provided by the bank. If the business loan is used to purchase machinery, the purchased machinery would be considered primary security. If the loan is for working capital (i.e., raw materials or stocks), the primary security would be the raw material, stocks, or receivables. In case of default in loan payments, the banker would have the right to hypothecate the primary security and sell it to recover the losses.
Banks prefer projects where strong primary collateral is created, which can be easily hypothecated and sold by the bank. For example, large machinery would be considered strong primary security, whereas interior decorations may be considered weak primary security, as they cannot be easily taken and sold.
Collateral Security
Bankers often request collateral security in addition to primary security, which the bank would automatically hypothecate. Collateral security is generally provided in the form of residential or commercial property. Agricultural property is not accepted as collateral security because it can be auctioned off under the SARFAESI Act. While unsecured business loan schemes are available, providing strong collateral security significantly increases the chances of obtaining a bank loan.
Promoter's Experience
In addition to the above criteria, banks also consider the promoter's age, education, experience, expertise, and background. While there are no set rules, bankers tend to prefer entrepreneurs with good experience and expertise in the business for which the loan is requested.
Promoter's Reputation
Bankers look for a blemish-free loan repayment track record when sanctioning loans. The banker will check bank statements for up to one year and the promoters' CIBIL score before sanctioning any loan facilities. Any history of cheque bounces, low CIBIL scores or repayment defaults can severely affect the chances of obtaining a bank loan.
Conclusion
Securing a business loan is an essential step for many entrepreneurs looking to start or expand their ventures. Understanding the eligibility criteria and the necessary documentation is crucial for a smooth loan application process. By ensuring that your business has a solid financial foundation, meeting the margin requirements, and providing the right collateral, you can significantly improve your chances of obtaining a loan. Additionally, the experience and reputation of the promoters play an important role in the approval process. While bank loans offer substantial support for growth, it's important to carefully assess your loan options and choose the best fit for your business needs.
