If India is to truly become a $5 trillion economy by 2025, then micro, small and medium enterprises (MSMEs) will need to play a pivotal role in contributing to the economy. MSMEs are vehicles of employment generation and socio-economic development, especially in rural and backward areas where most great firms and institutions have a negligible presence. MSMEs contributed nearly 30% to the Indian economy in FY22. There are 6.3 crore MSMEs employing nearly 11.1 lakh people, according to the FY22 Annual report of the Ministry for MSMEs. The implementation of GST has also removed most of the tax-related barriers to inter-state trade and has opened up the entire country as a market.
MSMEs have been unable to realize their full potential partly due to a lack of credit access, especially collateral-free financing. MSMEs need funding to expand their scale of operations and have to invest in equipment, working capital etc., for the same. However, the promoters/proprietors have constraints in terms of their own equity that they can invest in the business, and the rates offered in the informal loan market are too onerous and expensive for them. That left traditional bank loan funding as the available route, but this took a long time to process, and the traditional lenders insisted on hard collateral (real estate, FD lien etc.), which again restricted credit availability. However, over the past few years as digitization exploded, several fintech, banks, and NBFCs have begun offering MSME loans, both with and without hard collateral.
Here are a few key things you need to know about MSME loans:
1. Be very clear about the “Why” of your loan – When you’re availing a loan, be sure you know and understand its purpose. Be very well versed with the end goal of the loan, with each rupee marked down to a specific objective. Why you need the loan will eventually help you determine how much financing you require. Some lenders tend to track the utilization of the funds once they are disbursed, so being extremely clear and transparent beforehand will help you once your loan is approved. Creating a simple outline of your strategy will also help you understand the expenses involved and determine the repayment timeline.
2. Identify and assess costs carefully – Though interest on the loan is the highest cost associated with loan repayment, various other costs accompany it. Some lenders may attract you with low interest, but they may have many hidden expenses that will inflate your loan bill over the repayment period. Carefully look through all options available and take your time to evaluate and ballpark the loan costs of the most viable lenders. The aim here is to choose the ‘right’ loan at the ‘right cost’- one that will fulfil your objective and does not push your business into the red amid repayments.
3. Understanding collateral vs collateral-free loan – Some financial institutions and companies are willing to give MSMEs a loan without the need for security. Choosing an unsecured or secured loan depends on your business needs and goals. If you are determined to keep interest rates low, you would require the loan for a longer term and have significant assets (property, inventory, manufacturing equipment, etc.), then taking a loan on collateral is a better fit. On the other hand, if you lack assets that can be kept as security with the lender and are less sensitive to interest rates, taking an unsecured loan may be a better option.
4. Discussions with lenders – When lenders evaluate your creditworthiness, many will drop into your office premises to get a closer look at the operations. Alongside that, they will also have discussions with you to understand your business better and get a better idea about the roadmap of the company. Interact with representatives openly and answer honestly any questions and queries that they may have about your business operations. This will help build the lender’s confidence and will go a long way in ensuring that your loan application is accepted.
5. Business projections and cashflow matching are vital – If you have a viable business and you are eligible for an MSME loan, ensure that you have a clear picture of the target market and have made realistic financial projections for at least the next 3-5 years before applying for the loan. The projections should be based on factual and data-based insights, helped by reasonable assumptions. This will assist the lenders in evaluating your business’s financial feasibility and your ability to repay the loan. One should not forget to keep some buffer for project cost escalations and also account for increased working capital after capacity expansions. Also, one should try and tailor the repayment profile of the loan to match with the cash flow projections to avoid any cash flow mismatches.