Running a business requires capital, whether for expansion, managing cash flow, or purchasing inventory. Entrepreneurs thus often explore various financing options, such as business loans, invoice factoring, and GST loans, which are commonly used to fund and grow a business.
However, many businesses do not actually qualify for business loans for a range of reasons such as not being formally registered as businesses or not having large enough revenue or cashflow metrics to show, etc. Such businesses thus rely on friends and family, informal loan agents and personal loans to fund their business. For such folks, pledging assets such as land, property or gold are becoming common pathways to access business credit. In this blog we’ll cover the different types of business loans as well as less-known options such as using financial assets as collateral to secure business credit.
Understanding Business Loans
A business loan is a financing option specifically designed to meet the financing needs of businesses, and is issued to the business, as opposed to an individual. Lenders offer funds based on underwriting one or more of the following: the business, the promoters and the collateral the business or its promoter can offer - such as land, machinery, life insurance, FDs, gold, etc.
Business loans can be secured or unsecured, with various subcategories like GST loans and invoice factoring. These are all issued to formally registered businesses with entities. The most common types of formal Business Loans are as follows:
✔ Traditional Business Loan – A regular term loan for working capital, expansion, or asset purchase that is approved on the basis of the business’ performance and credit score. Whilst these are issued to the business, they could also require a personal guarantee from the promoter or director of the company in lieu of collateral. Some fintechs now offer terms that are tailored to the cyclical nature of some industries, most business loans follow a standard EMI based structure.
✔ GST Loan – Short-term credit based on GST filings are useful for businesses registered with GST (> INR 40L per annum), that have a consistent turnover. The loan issued in this case is essentially using the GST filed to estimate actual sales, and thus lending to fund a fraction of future sales based on the past months’ trend.
✔ Invoice Factoring – A financing method where businesses sell unpaid invoices to a lender at a discount to get immediate cash. This is a way for small businesses to monetise their receivables, as the customers can take 1-3 months to make payments, depending on the industry.
Key Features of Business Loans:
- Loan Amount: Varies, depending on business revenue and cashflow as well as the creditworthiness of the entity and its promoters.
- Interest Rate: Typically 10-24% per annum, depending on the lender and risk profile.
- Tenure: Short to long-term, usually 1 to 10 years.
- Processing Time: Can take days to weeks, depending on documentation.
- Repayment: Paid in EMIs, or linked to business cash flow.
- Collateral: May or may not require security, depending on the loan type.
Challenges with Business Loans
While business loans are an attractive option, as mentioned, not all businesses qualify for them. The biggest challenge is that most Micro, Small, and Medium Enterprises (MSMEs) in India operate informally, often without proper registration or GST filings. According to a survey by the Ministry of MSMEs, over 2/3rds of MSMEs in India are unregistered, making them ineligible for formal business loans. Banks and NBFCs prefer lending to businesses with verifiable financial records, excluding a large portion of small businesses from institutional credit.
- Registered vs. Unregistered Businesses: Businesses that are officially registered, maintain proper documentation, and file GST returns have a higher chance of securing loans. However, a significant portion of MSMEs function without formal registration, limiting their access to institutional credit. Only 1.5 crore MSMEs out of 6.3 crore are registered under Udyam as of 2023.
- Limited Credit History: Many small businesses lack a well-established credit profile, making it difficult for lenders to assess their repayment capacity. Without a track record of timely repayments, these businesses often face loan rejections. In India, over 60% of MSMEs have no credit history, further restricting their funding options.
- Collateral Requirement: Some business loans require promoters to pledge business assets as collateral or require promoters or directors to offer guarantees. However, many small businesses lack valuable assets and their promoters are unable to offer such guarantees, making it challenging for them to secure funding.
Given these challenges, asset-backed loans become a viable alternative for business owners who do not qualify for traditional business loans. Use the Sahi Secured Loan Tool to explore the various options available to business owners looking for affordable personal loans to fund their businesses.
In the next section, we will focus on one such loan type, loans against life insurance policies and how they could offer an alternative for business owners.
Understanding Loan Against Life Insurance
A loan against a life insurance policy allows business owners to use their policy’s surrender value as collateral to secure a loan. This is an alternative funding option for those who have long term savings that they can leverage towards funding their business.
Policy loans are available for policies that have accumulated a surrender value, such as endowment, ULIPs or money-back policies. This loan allows you to access funds without surrendering your policy, ensuring that you retain its benefits while meeting your financial needs.
At Mera Kal, we offer loan against insurance for policies issued by major insurance providers such as LIC, SBI Life, HDFC Life, Kotak Life, just to mention a few.
Pros of loan against insurance
- Retention of Policy Benefits: Your policy remains active, and its maturity and death benefits are intact.
- Lower Interest Rates: Typically, 9%-12%, much lower than personal loans.
- No Credit Score Requirement: Ideal for those with low or no credit history, helping to build a bureau profile.
- Quick and Simple Process: Minimal documentation and fast approval.
- Flexible Usage: Funds can be used for any purpose.
This loan is a great way to secure funds without losing your policy benefits, while also helping to improve your credit profile.
Comparison: Business Loans vs. Loan Against Life Insurance
Which One Should You Choose?
A Business Loan that limits any personal liability of the promoter is always a better option than the business leaders having to take on personal debt to fund the business. That said, business loans, GST loans and invoice factoring are typically good options for businesses that are already generating reasonable cashflow and require capital to expand by financing higher working capital and inventory. It is not a well suited option for those without a strong track record in the business, but who need to invest to start building this traction.
For such businesses, where the business owner needs to provide guarantees or to take on a personal loan, secured loans against financial assets such as policy loans against life insurance offer a great option. This is a loan that causes minimal disruption to the business owners’ overall financial plans, is affordable, and can build or improve their credit scores.
Business owners have multiple financing options, but the right choice depends on individual business and promoter financial needs, context and risk appetite. Reach out to Mera Kal over Whatsapp , if you need help in assessing your options.