Business loans provide borrowers the opportunity to avail lump sum cash or a line of credit to continue to operate and expand their business. These loans are provided based on the understanding that borrowers will pay them back along with the interest.
This capital is of particular importance to small businesses who can use it to invest in new equipment and supplies, pay their employees or or manage the flow of cash until their customers pay them their dues. Here are the types of business loans available and what happens when a borrower fails to pay them back.
Types of Business Loans in India
Popular business loans available for borrowers include the following:
Term Loan
Term loans are required to be paid at regular intervals over a set period of time. Accessible in the form of secured or unsecured loans, their capital limit is based on a given business’s credit history. The repayment tenure of term loans determines whether they are classified as short term or long-term loans.
Short-term loans refer to those loans that last a period of 12 months and tend to have higher interest rates to offset their short repayment period whereas long-term loans constitute a period that can last up to 10 years.
Once approved for a term loan, lenders provide businesses with capital in a lump sum amount. Businesses normally accrue these debts in order to purchase fixed assets including equipment or investing in a building.
Working Capital Loan
Businesses often avail of a working capital loan in order to finance their daily operations. Rather than being used to fund long-term assets or investments, working capital loans are used to finance a given business’s short-term operational needs.
As a collateral-free loan, it doesn’t require lenders to provide any collateral or security with the issuer. They can be used to tide a business over during an off-season and are taken advantage of by businesses that operate with cyclical sales.
In comparison to long-term loans, working capital loans are provided with a comparatively higher interest rate. Lenders determine the limit of the loans they offer and said capital can only be spent on specified business-related expenses.
Overdraft Loan
Business accounts can take advantage of overdrafts offered by most lending institutions in the event that their accounts have a balance equivalent to zero. Overdrafts thereby allow for businesses to continue to withdraw money even when their accounts have no funds or, when the amount they wish to withdraw surpasses the amount they presently have.
The interest rate applies only to what is utilized based on the sanctioned limit. Overdraft limits are determined by lenders once they’ve analyzed a given business’s cash flow, their repayment history and the fiscal relationship between them and the business.
Startup Loans
The success and sudden expansion of startup ventures within India has made it possible for any given startup to consider loans that have been designed keeping in mind their fiscal needs.
Since startups are essentially businesses at their earliest stage, entrepreneurs behind such operations might not be able to provide lending institutions with a significant credit history. In such instances, lenders take into account an entrepreneur’s personal credit history as well.
They are also required to provide proof of their business existing, as well as registration details. Varied financial considerations are taken into account when lenders determine the capital they will lend along with the tenure and interest rate applicable.
Equipment Financing
This is largely popular with manufacturing businesses or large enterprises that often need to purchase expensive equipment or upgrade their existing machines.
Business owners are eligible for tax benefits if they avail such loans. Due to the specific nature these loans are allocated for, the equipment itself is treated as collateral along with another security.
Interest rates for such loans tend to be lower than those charged on term deposits. The interest rates, the loaned amount and repayment plans largely depend on the lender in question.
Government-Funded Loans and Schemes
The Indian Government provides an array of loan schemes that target varied entrepreneurs based on their lending requirements, business plans and business size. There exist special loans available to female entrepreneurs as well as those targeting micro, small and medium enterprises (MSMEs).
These loans are available via a number of financial channels including private and public sector banks, regional rural banks, micro and small finance banks as well as non-banking financial companies.
Loan schemes offered by the Indian government include, but aren’t limited to, Standup India, Startup India, MSME in 59 minutes and Pradhan Mantri Mudra Yojana.
Letter of Credit
Serving as a key factor in international trade, letters of credit are often used by businesses that deal with work overseas.
They serve as funding guarantees provided by lending institutions on behalf of their borrowers that are made available to foreign entities.
Letters of credit can be obtained from banks for a fee. They act as an assurance that a buyer’s payment to a seller will be received within the requested time frame and for the full amount.
Merchant Cash Advances
Such loans comprise cash advances against future sales. They are popular among businesses that derive a large amount of their revenue from credit card sales. These include restaurants, retail stores and medical offices. Borrowers pay off their debt as and when they sell their wares to customers.
In order to prevent themselves from experiencing a short-term deficit in their cash flow, small to medium enterprises often avail of these loans. As businesses repay their debt as per their daily sales, the amount deducted from sales each day depends on how many sales occurred.
Invoice Financing
Similar to merchant cash advances, these loans provide businesses with fast access to cash. However, they are often availed of at lower interest rates as the loans are set against existing invoices rather than projected sales.
They are largely popular with small businesses that experience a time lag between providing invoices and receiving payments for the same. Lenders provide funds against amounts raised in the borrower’s invoices. Debts are cleared by businesses once they receive their invoice payments as per predetermined tenure and interest rates.
In addition to the Indian federal government and private banks that provide business loans, a number of online lenders offer business loans. In case of nimbly accessible loans, defaulting on recovery has its own consequences.
Consequences of Defaulting on a Business Loan
Varied scenarios including a drop in sales, overspending and miscalculations can all lead to businesses defaulting i.e., being unable to repay debts including the interest or principal on a loan. Defaults occur when borrowers are unable to stand by their debt obligations and either stop making recurring payments, skip payments or stop making any payments altogether.
The consequences incurred for defaulting on a business loan depend on whether they were secured or unsecured.
When Secured Loans Are Defaulted: In the case of the secured loans, foreclosures allow lenders the right to gain control of assets provided as collateral under the loan agreement. This collateral is often auctioned in order to account for the lender’s losses.
When Unsecured Loans Are Defaulted: In the event that an unsecured loan was defaulted, business owners are charged with a late fee. Lenders may also require personal guarantees or may gain control of a business’s assets. Failure to comply with these requests can result in lenders filing lawsuits against businesses that default. The court then determines how the loan is to be recovered. In the event that the loan continues to remain unpaid, the business in question may have to file for bankruptcy.
Repercussions of defaulting business loans are visible in credit scores. Lenders report failure to pay loan instalments to credit agencies each time business owners are found lacking. This can lead to a drop in credit scores, which in turn can imperil the possibility of future loans being approved.
Inverse to a plummeting credit score is a consequent soaring interest rate based on the stipulated business loan agreement. If the interest rate remains the same, borrowers are subject to exorbitantly priced late fees. This directly affects a borrower’s existing loan repayment and also contributes to their ability to avail of loans in the future.
Ways to Avoid Defaulting on a Business Loan
In order to avoid defaulting a business loan, entrepreneurs and business owners are advised to observe the following.
Maintain Reserves: All businesses can incur volatile market conditions. In order to withstand these, maintaining a sufficient business bank account balance is advisable. This balance should ideally include three months’ worth of loan repayments that shouldn’t be allocated towards or spent on anything else.
Diligence About Due Dates: Business loan borrowers must be well aware of dates on which each of their repayments are due such that they are fiscally prepared to pay them. While a sole missed repayment might not directly result in defaulting, it can accrue high fees.
Refinancing: Several lenders allow business loan borrowers to refinance their existing loan by providing them with new interest rates, payment schedules or altering other previously agreed upon terms.
It is particularly appealing to new businesses as short-term loans often end up hindering the very momentum they initially provide. Numerous lenders are therefore ready to refinance these loans which cover longer periods and ask for smaller instalments. Refinancing is not a solution and only a precautionary measure to remain in the clear.
Borrowers who feel they may not be able to pay upcoming instalments with ease must relay these sentiments to their lenders. This proactive behavior could be rewarded with extended terms.
Reschedule Debt: In the case of excessive expenses incurred by a business, business owners can reschedule their debt i.e., they can restructure their terms of repayment. This is done by extending the time period required to repay a loan and by increasing the number of times said payments are to be paid. While this has the potential to reduce credit scores, it is preferred to defaulting.
Prioritize Debt Repayment: Repeated loan payments must be given the most priority as they cannot be shirked. All business expenses must be viewed second to it.
In the event that a business owner cannot avoid defaulting, they must seek legal counsel in order to stay afloat. Borrowers must only borrow what they need and not get ahead of themselves.
