Bank Loan for Startup Business

Securing funds for a startup is one of the toughest challenges an entrepreneur's faces while starting a new business. With a plethora of funding options available, it is important for the Entrepreneur to understand the pros and cons of each funding methodology, estimate the value of funds required, the application of funds, projected financial position of the business including the returns generated and evolve a strategy - to approach and secure the required funds. With venture capital firms and angel investors enjoying plenty of coverage as a great source of funding for a startup, many Entrepreneurs are unaware that financial institutions and Banks are also an avenue of funding for startups. In fact, Banks are one of the largest funders of startups in India, providing funding to thousand of startups each year. In this article, we cover the types of funding available from banks as loans, along with a host of other questions surrounding bank loans for startup businesses in India.

Do banks provide loans for a startup business?

Yes, banks and financial institutions provide financial assistance for companies in all stages of the business lifecycle. Startup companies can avail of a host of term loans or working capital or asset-backed loans based on their requirements. Banks will lend even to a start if they are satisfied with the business model, projected returns from the business, the ability to pay back the loan (through business or otherwise), management experience and expertise, and other security provided.

Will banks provide loans for startups in novel areas?

For companies starting up in novel areas where the business model has not yet been established, banks will typically insist on higher collateral security coverage, typically with other sources or back-up sources of income. If the same can be provided, banks will lend to a startup with novel business models as well.

As a startup, can I get a bank loan for research and development of technology?

Yes, it is possible to obtain a bank loan for research and development of any technology from banks. Asset-backed loans can be used for developing newer technology or marketing or other business expansion efforts. The bank provides Asset-backed loans based on the market value market of a residential, commercial, or industrial property. Banks lend up to 70% of the assessed market value of the property with a loan tenure of 7-15 years. In addition to the collateral security offered, the promoters will have to display to the Banker the financial returns expected from the business and source of funds for meeting the loan's interest and principle commitment on time.

As a startup, can I get a bank loan for buying equipment or machinery?

Yes, a startup can obtain term loans from banks for buying equipment or machinery. Banks are more favorable towards extending loans for purchase, erection, and commissions of capital assets such as machinery or equipment for use in business.

As a startup, can I get a bank loan for stocking inventory?

Yes, a startup can obtain working capital loans from banks for stocking inventory or providing credit to customers. Banks will try to assess the working capital requirement of a business based on the projection provided and take a conservative approach to lend working capital funds.

Can startups get a bank loan without any collateral security?

The Credit Guarantee Fund Trust Scheme for Micro, Small and Medium Enterprises (CGTMSE Scheme) provides a framework for the Banks to extend up to Rs.1 crore of a loan without any collateral security toward term loan and working capital requirements of a business (NOT for marketing or technology development). Therefore, startups that require capital assets or inventory can utilize the CGTMSE scheme to obtain collateral-free loans from the bank. The banks provide loans under the CGTMSE schemes are very selectively for very deserving Entrepreneurs who exhibit very good financial and managerial acumen. Therefore, only a very few startups obtain funding from banks under the CGTMSE scheme to start their operations.

Are there any specific loans or schemes for startups?

Yes, many banks and financial institutions offer schemes aimed at startups. For instance, SIDBI offers "Growth Capital & Equity Assistance" for SMEs that require capital for growth. The funds from SIDBIs "Growth Capital & Equity Assistance" scheme can be used for marketing, brand building, creation of distribution network, technical know-how, R&D, and software purchase.

SIDBI also offers the SIDBI Revolving Fund for Technology Innovation-(SRIJAN Scheme), which provides financial assistance to MSMEs towards development, upscaling, demonstration, and commercialization of innovative technology-based projects. The bank provide assistance in the form of early-stage “debt” funding on softer terms for development, demonstration, and commercialization of new innovations in emerging technological areas, un-proven technologies, new products, processes, etc. which have not been successfully commercialized so far. Maximum assistance is generally not more than Rs. 1 crore per project. The interest rate would be as approved by the Project Approval Committee (PAC) (not be more than 5% p.a.).

How should a startup approach a bank for funding?

Prior to approaching a banker or an investor with the request for funding, the promoters of the business must first prepare a pitch that explains the business model, promoters background, revenue model, estimated sales, estimated profit, estimated growth rate, and returns. Return on investment is a key factor for both banks and equity investors. Therefore, it is important for the promoters to gather, familiarize, and compile the information in a presentable format first (could be a Detailed Project Report). Once the investment pitch is ready, the promoters must keep potential identity banks that have schemes or the facility for providing the requested funding. It is important for the promoters to structure their request in a way it would fit into the framework of RBI's and Bank's lending policy, i.e., not requesting funds for marketing at an institution that provides only term loans. Once the above two steps are complete, they can approach the bankers, present the pitch, and request for funding.

What are the advantages of securing a bank loan for a startup business?

There are various benefits if a startup can get a bank loan instead of venture capital in the startup stages. 1) Venture capital funds are very costly, with VC investors expecting 5-10 times return on their investment. However, bank loans do not require equity dilution, and the rate of return to the bank is already at a nominal amount of about 13-17%. 2) Banks are easier to approach. With banks available everywhere in India, it is easier to approach your local banker and request for funds that were meeting a Venture Capitalist or Angel Investor. 3) Established a framework for funding evaluation. Banks have a well-structured framework for processing funding requests. Therefore, an answer to your request for funding will be processed more quickly than when compared to a venture capitalist or angel investor. 4) The profits/loss of your business belongs only to you.