Startup-Debt Financing

Startup-Debt Financing as an option for growth

Startup- Debt financing as an option  to grow after having invested their own cash in the beginning.One of the options is to approach banks for loan. Borrowing money from banks still keeps the entrepreneurs in control unlike giving shares to a partners or seeking funds from venture capitalists.

“No loan is free. The costs are in your loan somewhere, maybe rolled into the amount to be refinanced or even coming at a higher interest rate.”-Barbara Corcoran

Source:Ecell iitkanpur-Gaurav Doshi

Startup-Debt Financing Options

Short term-The working capital loan

Startups-Debt Financing has two options-Short Term & Long Term.

 Startups need money on short term to manage cash flow. The working capital loan is easier to get provided entrepreneurs have been transacting through that bank from commencement of the business.

They can get loan as overdraft facility against raw materials, work in process and finished goods as collateral. The interest has to be paid every quarter.

The banks renew the limits every year. Banks also expect the entrepreneurs to have t least 5 times the overdraft as the turnover. 

Long term Loan

Entrepreneurs who want to acquire assets like building, machinery etc require capital. They need to submit business plan or a project report to the bank. The capital is to be repaid over a long term period of 5-7 years along with interest as EMI. The assets procured has to be offered as collateral and cannot be removed or disposed off without the bank’s approval. The entrepreneurs need to bring in 20% of the total finance required upfront.

There are also equipment lease options where they need to pay lease rentals on a monthly basis.

This helps the entrepreneurs to convert fixed to variable cost while minimizing  minimizes the business risk and technology obsolescence.

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Exceptions to Long term Loan

This loan is for mainly asset based business. Service industry or intellectual capital based business will not be able to get long term  loan.

“We’re a software business, so it’s not like I have a ton of machinery that can be used for collateral,” Barach says. “Bank financing is just very hard to get, so we had to be creative about this

 Startup-Debt Financing-Demystifying Bank Loans

The largest source of funding is from commercial banks for entrepreneurial ventures. The government is keen to promote entrepreneurship and has even mandated banks to give loan for startup enterprises without collateral.

 Many a times we hear from entrepreneurs that banks are unwilling to lend them .Why are entrepreneurs not able to get loans? The main reasons according to a seasoned banker of two decades are that starts up entrepreneurs do not understand the bankers’ perspective of granting loans and as a result their project suffers. 

 Startup- Debt Financing Bankers Perspective

They have a team which includes experts having domain knowledge to assess the viability of the business. Normally bankers lend ,based on their evaluation of project viability but the overriding concern is the assessment of entrepreneurs themselves.

  1. Good People to lend:
  2. Possibility of returning the money
  3. Intention to repay
  4. Ability to repay

Entrepreneurs’ may be wondering how the above is determined by bankers. Is it purely the qualitative assessment of the individual by bankers or is there a quantitative measurement available

Assessment-Indian Context

The government has set up an organization called CREDIT INFORMATION BUREAU (India) Ltd. (CIBI)

The CIBIL Trans Union Score is a 3 digit numeric summary of  the entrepreneurs ‘credit history which indicates their financial & credit health The borrowers’ credit score tells the lender how likely they are to pay the  loan back  based on their past repayment behavior. The higher the score, the more the chance of their loan application getting approved!

The credit score can be checked for a small fee.

Nuggets- Startup-Debt Financing

  1. Working Capital loan  smoothens Cash Flow
  2. Enables asset Acquisition
  3. Loan repayment Credibility 
  4. Relationship with bankers  right from the word go