What is Business Loan? A Complete Guide.

How Does Business Loan Work?

India ranks third in having the most extensive small business network in the world.
Entrepreneurs can become successful by following their passion, ideas, and showing dedication to their work.
However, micro and small industries also require money to grow and control their business and prosper in the market.
Noting the number of small businesses cropping up in India, the government has introduced business loans to supply funds to micro, small, and medium enterprises (MSMEs).

What is a Business Loan?

A business loan is a loan primarily used for business reasons.
Like all other loans, business loans also entail debt, which has to be repaid with interest.
Business loans are of various types, such as SBA loans, mezzanine financing, asset-based financing, bank loans, invoice financing, microloans, online lenders, business cash advances, and cash flow loans.
Business loans can be secured or unsecured.
With a secured loan, the borrower puts up a resource against the debt taken.
If the borrower cannot repay the debt, the moneylender has full rights to claim the asset pledged by the borrower.
On the other hand, unsecured loans do not have any security or pledge, though the lender can claim an asset of the borrower if the latter isn't able to repay the debt.

Evolution of Business Loan System in India

Today, over 60 million micro and small enterprises are operating in India.
These enterprises are contributing to 30% of India's GDP and recruiting over 111 million people.
But a considerable obstacle to their growth has been the factor of securing credit.
Even today, informal sources of credit meet only about 40% of the entire MSME credit demand.
According to the IFC Report 2018, the colossal financing gap stands at INR 45 lakh crore.
Of the total credit demand, informal avenues disburse 40%, 25% is met through personal loans, and formal credit modes manage to satisfy only around one-fifth of the total credit demand.
While microfinance institutions and banks tend to corporates’ needs, the MSME sector has always had fewer choices.
Small and micro industries often have no property in their name, and many of them have insufficient credit.
A lack of proper documentation and a weak balance sheet doesn't work in their favor either.
Also, long approval and disbursal periods for credit are specifically tricky for small businesses.
Only a few conventional financial services providers make it easy for micro and small industries to take small loans.
These trends pose barriers and restrict MSME growth.
These are the circumstances that have led to a new era of lending.
Different finance companies equipped with funds from technology and venture capital sources have been taking up the challenge.
According to the BCG Omidyar report on MSME lending, for business processes, online sales, and payments, 47% of micro, small and medium enterprises have embraced digital tools.
These tools make it easier and provide the required support to take a business loan.
The cash flow footprints play an essential role in supplying a working capital loan to an SME.
Further, in the last three years, the cost of data has dropped by 95%, leading to accelerated growth in mobile phone use.
Today's loan providers use digital devices and payment tools and share data on social media platforms to arrive at a credit conclusion.
These capabilities wouldn't have been on offer for the new-to-credit MSMEs earlier.

Small Business Loan

Micro businesses are now doing away with loan providers that charge up to 90% annualised interest rates on loans and opting for loan offers from various banks and non-banking finance agencies.
The price of credit here is low and the contract is more precise with pre-established payment terms.
According to Tracxn, from 2014 to 2016, India witnessed more than 50 lending agencies appear each year.
These agencies are equipped with venture capital that enables them to utilize technology.
They also scale more quickly in a shorter period, compared to a typical bank that decides to launch an SME branch in a semi-urban region.

MSME Loan Initiatives

The Government of India has taken the initiative to establish business loan schemes for MSMEs and business startups.
The arrival of digital KYC, EPFO data, and GST returns data makes time-reduction in loan processing possible and improves customer experience across all interactions.
This evolution could improve the MSME digital lending landscape, and annual disbursements could increase to Rs. 6-7 lakh crore by 2023.
To show cash flows, retail and e-commerce agencies can efficiently utilize their transaction data through the point of sale terminals.
They can also acquire funds for a duration of 12 to 36 months at competitive prices.
While the present-day models can be seen as challenging banks' superiority as preferred loan providers, there are chances for further disruption.
We are now confronting a rehauled era of co-lending, with banks signing and teaming up with other loan providers and NBFCs.
This will result in cheap rates of acquisition and favorable conditions for all concerned stakeholders.

Factors in Business Loans

Moreover, loan providers are signing up with Fintech as well as present-day lending NBFCs to make sure that they keep their market share while boosting the experience for SME clients.
It's time for loan providers not to be doorkeepers of credit and become business growth associates for billions of Indian people in the business.
With the formalization of account association, loan providers will get prompt access to the client's digitally checked asset data directly from different sources, which also include banks, equities, mutual funds, GST, and Income Tax.
This can eliminate the paper and fraud risks linked with them, resulting in further optimisation of loan processing time and a superior customer experience.
Moreover, the digital MSME loan providers have a substantial positive social effect on the MSME sector by providing business loans to new-to-credit loan borrowers and first-generation entrepreneurs, therefore enabling these customers to enhance their livelihood.
Additionally, these MSME loan providers are enhancing the scope of financial inclusion by focusing on providing loans to small and medium industries in tier II and tier III cities.
MSME loan providing can protect India's economy with a constant slew of measures implemented by the government for small- micro industries and NBFCs, increasing acceptance of digital modes of payment, and merging of GST returns data with payments and digital trials.
Enhanced SME lending can boost India's economy with the much-required determination and energy that one would expect from a fast-developing and expanding world economy.
Following are some popular schemes initiated by the Indian Government for MSMEs:

Bank Credit Facilitation Scheme
Pradhan Mantri Mudra Yojana (PMMY)
Credit Guarantee Scheme (CGS)
Standup India
Sustainable Finance Scheme

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Frequently Asked Questions

Often many small business owners are stuck with several questions about the process of securing small business loans. Towards this, we have answered a few relevant FAQs.

Q- How many types of small business loans are there?

Ans- There are two types of business loans offered by the loan provider. They are term loans and working capital loans.

Q- How old does a small business need to be to apply for a small business loan?

Ans- To claim a business loan, a small business should be a new firm or five years old at the maximum.

Q- What are the documents required for applying for a business loan?

Ans- The following are needed: Identity proof, such as PAN card/voter's Id/driving license; address proof, such as electrical bill; passport size photograph; shop certificate, income proof; and bank statement.

Q- What is the eligible age for a business loan?

Ans- The age of the borrower should be between 24 and 65 years.

Q- Is a business plan compulsory to apply for a small business loan?

Ans- Yes, most loan providers will ask you about your business plan when you wish to avail a business loan.