Let us consider the following hypothetical scenario:
ABC & Co., a small services firm, began operations in mid-2011. It reported a 40% jump in annual turnover from Rs. 5 Cr in FY 2012 to Rs. 7 Cr in FY 2013. As a startup, the company has not yet broken even and reported losses for consecutive years. The promoter is well educated, previously worked in organizations of repute for over a decade before deciding to float this venture. The short-term finance requirement of ABC & Co is about Rs. 40 lac for 90 days, but does not have any physical collateral to offer as security. At this stage, the promoter of ABC & Co. decides to approach banks and NBFCs in the market to fund this debt gap.
What would this promoter’s experience be in today’s scenario? Would he be successful in securing the necessary funds?
According to a recent statistic, 33% of companies operating in the Micro, Small and Medium Enterprises sector have access to banks and financial institutions, while the rest remain excluded and are compelled to raise money through informal channels.
This debt gap is alarming especially in the backdrop of the fact that SME segment contributes nearly 10 percent of the country’s gross domestic product and 45% of all industrial output.
Till date, banks and NBFCs have not been able to finance this debt gap effectively. What has prevented or restricted them from profitably penetrating this sector? Is it due to inherent credit risk in the segment, lack of collateral, government regulation and laws, or simply because there are greener pastures elsewhere to lend money?
Lets us understand the debt requirement of the SME segment (both early-stage as well as mature entities) before we try to further dissect this issue. In our example, ABC & Co. could require financing for primarily two reasons:
1) Capex, i.e. medium to long-term finance for business expansion, product diversification, renovation of business premises, or purchase of machinery.
2) Working Capital i.e. to cover short-term immediate cash flow needs arising from day-to-day business operations.
To cater to this demand, banks and financial institutions already have specific products (both fund and non-fund based) that can be broadly categorized into two categories for the sake of simplicity:
1) Simple lending products, which would typically cater to the first requirement of SMEs for Capex. These are medium to long-term financing products in the form of equipment and machinery loans, high yield unsecured business loans, Loan against Property etc.
2) Specialised lending products, which typically include factoring, trade finance, cash management services, project finance, bank guarantee, or letters of credit, which typically cater to the second requirement of working capital finance.
As is evident from the above, it is not the lack of “products” that explains the under-penetration of finance flowing to the SME sector. Rather, it is in the design, applicability and administration of these products to the SME sector that banks have fallen short.
In an effort to go deeper, we can identify four key reasons among others, for this shortfall:
1) Sole Focus on Financials: The current approach to SME lending in most institutions is still heavily dependent on business financials- i.e. looking at historical data to predict future creditworthiness. Typically this involves a lot of paper work and many visits to the applicant.
This approach has not been very successful in the SME sector to-date due to the fact that the financials provided by the applicant are often opaque given the cash nature of business transactions and incentives to under report income to save on taxes. ABC & Co., on this parameter alone (aside from business vintage) would be filtered out as the current financial position reflecting business losses would not be very appealing to most financiers.
2) Bureau Reporting: There are two kinds of credit bureau reports that can be generated by member banks and NBFCs – Individual and Corporate. While individual records are provided by most bureaus, only CIBIL currently provides reports for corporate entities in India. Valid records for SME entities are still not very evolved in the country. And while the bureaus can provide data on credit worthiness of the individuals involved in any given company, they cannot give relevant insights about an applicant who is a first time borrower.
Since ABC & Co. is newly established, there would not be any bureau record on the company. The application would then have to be judged on the strength of the individual records for the promoter as well as the business viability of ABC & Co.
3) Selective Segmentation: The implication of the above two factors is that only the “upper layer” of the medium to large enterprise segment is able to pass through banks’ and NBFCs’ credit assessment parameters, leaving aside the major chunk of “small” entrepreneurs and entities whose need for adequate finance is more pronounced. These small entities could be major links in the supply chains of large players, and their inability to access finance could have the ripple effects across the value chain.
4) Lack of Collateral Security: Lending in India traditionally has relied on taking adequate collateral as a “risk mitigant” to cover the credit risks associated with SME lending and the ambiguity around appraising this segment. The Loan to Value ratio (LTV) becomes the yardstick to segregate and approve or reject cases based on risk. This ratio is inversely proportional to the risk perception of the applicant.
Since ABC & Co. does not have any physical collateral such as property or machinery to offer and the promoter has pitched in whatever money he had in the form of initial capital into the business, his application would be rejected by most banks and NBFCs in the market today.
This problem of access to finance for SMEs in India is even more accentuated for early-stage companies or startups such as ABC & Co. In their case, past financial performance would be not a correct indicator of the future potential of the enterprise. After initial round of equity funding from family and friends or seed investors, working capital requirements or ad-hoc needs for short term finance would inevitably kick in and must be dealt with in a timely manner to keep the firm operational.
To conclude, traditional lending to the SME sector in India can best be described as a “One Size Fits All Approach.” The risk management techniques used by banks and other financial institutions today are invariably more suitable for medium and large corporate entities. The same set of rules when inadvertently applied to small and early-stage enterprises result in a faulty output, i.e. the systemic rejection of most SME loan applications like ABC & Co. Given the intense nature of competition in the lending industry today, the consequence is that too many banks and financial institutions end up chasing the same set of “good” customers, leaving aside a much larger untapped segment of SMEs in the process.
Watch this space for more articles on the subject as well as suggested ways to underwrite “small” and
“early-stage” entities in the SME sector.
(Image credit: http://blog.directcapital.com/misc/small-business-loan-video/)
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Are you a dynamic entrepreneur whose ultimate goal is to turn your passion into reality? Are you looking at starting or expanding your small and medium-sized enterprise (SME)? Do you believe that all you need is a push to fulfil your dreams? In that case, you can look at any of the several sources of business loans – banks, non-banking finance companies (NBFCs), government institutions, venture capitalists – that are here to work with you as a partner to help actualise your business ideas.
In the current economic climate of India, SMEs are in constant need of funds to expand their businesses, meet working capital needs, or make optimal use of business opportunities. Business loans, either from traditional sources or from FinTech companies such as Capital Float, can provide an optimal solution to meet such financial requirements.
Such loans, besides their obvious benefit of the right funds at the right time, carry several advantages that make their choice a good one. Here is a look at the benefits of availing a business loan for expansion:
1- Helps with the cash flow
Business loans can be either utilized to boost revenues or to gain competitive edge. So a company may look to open a new branch, launch a marketing campaign, add to inventory for seasonal demand spikes, and so on. Any money can be good money, provided it is used efficiently and wisely. You can opt for short- or long-term financing, small loan or large, whichever works well for you. The idea is that the income generated from such avenues goes towards repayment of the loans, and leaves a tidy sum for you to use otherwise. You get to achieve your business goal without having to spend your cash.
Banks are generally the first choice when it comes to applying for loans. Their primary advantage lies in their accessibility and familiarity, especially for long-term customers. Although it is tough to get a loan approved, you carry home the satisfaction of getting away with lower interest rates. Also, unlike venture capitalists and angel investors, you need not part with either ownership or profits from businesses.
2- Simple and speedy loan disbursal process
New age FinTech companies in comparison are catering to a huge demand for business loans by focusing on start-ups and SMEs. With government support and positive economic outlook working in favour of such ventures, there is massive scope for funding new businesses or expansions. Digital lending platforms tap this market by providing business loans, which work well for the borrower as well as the lender. The loan processes are simple, friendly and hassle-free. Capital Float is one such company that offers small business loans in a simple 4-step electronic process, ensuring enhanced customer experience.
All you need to do is fill up the online application form by visiting www.capitalfloat.com from anywhere, anytime, and upload the required documents. The minimal, hassle-free, and user-friendly documentation process is followed up with on-time finance disbursal to borrowers. Specialised companies like Capital Float ensure that your loan is disbursed within 72 hours.
3- Customised solutions for SME needs
Business loans can give the ultimate boost to your company in an efficient and effective way. Banks as well as Fintech lenders like Capital Float believe in the uniqueness of every business, and provide a wide range of flexible, tailor-made loan products that cater to the specific business needs of SMEs in India. You can choose the most suitable option that meets your requirements.
The repayment options are equally flexible. Based on your financial needs, most lending companies provide you business loans ranging from Rs 1 lakh to Rs 1 crore for varied tenures. For example, you can avail business loans for a tenure of 1-12 months with no pre-closure penalties and extremely flexible repayment options (ranging from 12 months to 36 months) from Capital Float. These features are designed to specifically cater to the needs of SMEs in India. SMEs taking loans against receivables can repay it in a single “bullet” instalment at maturity, while those taking unsecured loans can repay through EMIs.
4- Competitive interest rates
Not only banks, certain NBFCs and other lending companies can also offer business loans at competitive interest rates. Capital Float for instance provides business loans to small and medium businesses in India at very competitive interest rates, nominal processing fees, with absolutely no hidden charges. These features make FinTech companies like Capital Float some of the most preferred lenders in the present small business loan market.
5- Collateral free finance
Business loans provide financial support to a very wide range of SMEs, such as B2B service providers, manufacturers, traders, or distributors. Companies like Capital Float work as a partner to provide seamless support to SMEs in fulfilling their dreams. You can avail collateral-free finance, which doesn’t require you to pledge any property or asset to get a business loan. Your business is evaluated based on the strength of your cash flows and expected receivables. Any SME with a minimum of one year of business operations can avail of such business loans.
Very few lenders really believe in embracing new ideas with open arms. New-age lenders however are more willing to invest in new ideas. Capital Float, for instance, provides small business loans to new-age businesses in India along with financing the needs of traditional businesses.
Oct 24, 2018
A wave of change is sweeping across the nation, transforming accessibility of credit at an individual and institutional level. As stated by the World Bank in 2014, nearly 47% of Indian adults are disconnected from formalized financial systems, increasing their dependency on informal credit channels. The nature of these informal channels and the environment fostering their sustenance make these modes of funding exorbitantly expensive. These channels typically provide immediate funding but debilitate the borrower’s sustainability and competitiveness in the long-term. Usurious rates of interest, loans terms disconnected from business fundamentals and delayed-decision making shackle entrepreneurs armed with ambition.
The apprehensions involving credit-access notwithstanding, SMEs find themselves lucratively placed in the timeline of the Indian economy, wherein Governmental and capitalistic forces are aligning in order to further SME progression in the country. Centre-led initiatives and evolutionary processes set up by tactful corporates are becoming building blocks to facilitate economic development through SMEs.
SMEs central to India’s economic development
The Government of India has identified the significant role SMEs play in shaping and developing the economy. The ‘Make in India’ initiative was launched last year to attract foreign and local investment to the country’s manufacturing sector. SMEs are required to participate actively in making this initiative a success. The pro-manufacturing stance of the Government provides these businesses with the opportunity to scale and grow at an accelerated pace.
India destined to become an e-commerce superpower
Similarly, e-commerce companies in India are in the golden phase of technological advancement. According to Goldman Sachs, India’s e-commerce market will cross the $100 billion mark by FY20. A study by PWC indicated that the e-commerce industry is expected to grow from $16.4 billion in 2014 to $21.3 billion in 2015. Alibaba.com, the B2B division of the world’s largest e-retailer Alibaba Group recently announced that India is the second most important market for the company globally . A whopping majority of the e-commerce space presently comprises of e-tailing and e-travel companies. Alibaba is likely to provide B2B companies the much-needed platform to establish their presence.
Credit now just a click away
Several factors could hinder SMEs from expanding at a geometric rate. Possibly the most critical of these is credit. Companies are queuing to alter the perception and approach to credit, with many organisations attempting to transform finance from a function to a service.
A recent article on YourStory mentioned that over 500 financial technology start-ups in India have received $1.4 billion in funding since 2012. These are not merely in the credit services sector but also include companies in the mobile payment services sector. With 90% mobile phone penetration in the country and smartphone sales expected to reach 500 million units in the next five years, digital engagement with consumers will be higher than ever before.
Pioneer with purpose
Capital Float, the pioneer in digital lending for SMEs in India, is spearheading this digital revolution. We understand the crippling effects collateral-based loans have on business progression and the inherent anxiety they cause. Our expertise in big data, decision sciences proficiency and technological prowess gives us the edge to provide specially tailored financial services to small and medium businesses across the country. Competitive interest rates make us relevant and digital platforms increase our reach. Gone are the days when SMEs toiled to acquire credit. Digitized processes have bridged the gap between the borrower and capital, the two now being separated by a few clicks of the mouse.
Digital Lending will gradually replace conventional credit channels. In response to the altering financial landscape, traditional organisations are revisiting their work-flows and are attempting to revitalize processes to become felicitous options.
SMEs are evolving at a rapid rate and it’s not surprising that access to finance too is changing simultaneously.
Author – Rajath Kumar, Marketing Manager, Capital Float.
Oct 24, 2018