Every small business or startup is a dream come true of an aspiring entrepreneur, and it all begins with self-funding or business loans.
In the last few years, the number of small businesses has increased due to government support and the easy availability of business loans in India. As per data, small businesses increased by 18.5% from 2019 to 2020. Also, in the financial year 2021, these small businesses’ disbursed loan amount increased to 9.5 trillion. In 2020, this loan amount was 6.5 trillion, which made the government double the budget for small businesses in 2022. This gradual growth in both the small companies and the loan amount shows how the concept of business loans is becoming popular in India.
There are differences in lending procedures between SMEs (Small and Medium Enterprises) and other business loans.
Small businesses have to meet certain specific criteria to be considered in the category of SMEs, including:
- Small businesses must have investments ranging between 1 Crore to 10 Crore
- The turnover of small businesses must not cross 50 Crore.
Notably, the total number of SMEs in India is 42.5 million, which covers 95% of the entire Indian business industry.
Key Characteristics of a Small Business Loan
Small businesses are different from traditional businesses, so the loans sanctioned to them are specifically designed to suit the requirements of both the lender and the borrower.
Here are Some Ways an SME Loan is Different from a Standard Business Loan:
- A business loan is granted to an established organisation, while an SME loan is to help a small business with capital.
- Another significant difference between a typical business loan and an SME loan is the required documentation. While most business loans require a lot of documents to prove credibility, SME loans are easier with documents since most small businesses are still in the initial phase.
- The interest rates are lower for SME loans. While a business loan might have 12% to 24% interest rates, an SME loan will have a maximum of 3% interest rate.
- SME loans take less time to disburse than a traditional business loans. The government of India has a policy mandating the disbursement approval and transfer for these loans within a maximum of seven to eight business days of application.
With a clearer understanding of SMEs and different types of business loans, let’s move on to know the factors that affect SME loan interest rates in India.
Here are five factors that affect the interest rates of SME loans in India.
#1 Secured and Unsecured loans
The main difference between a secured and an unsecured business loan is assets. While the secured loans are backed up with collaterals, unsecured loans do not have any such requirement. Instead of collateral, a “blanket lien” or a person serves as a “personal guarantee” for unsecured small business loans. As a result, the interest rates for unsecured business loans are higher than for secured loans. Since most small businesses are startups, they are forced to choose the unsecured loan option with higher interest rates.
#2 Credit Score (CIBIL Score)
The CIBIL score can impact the interest rate of a small business loan. A good CIBIL score is over 700, which is determined by the financial behaviour of the company. This score reflects the borrower’s repayment behaviours in the past two years. It is crucial to repay the debts on time, file ITR, repay EMIs and existing loans on time, and timely pay credit card bills to maintain a good CIBIL score. Take care of all required financial activities promptly. The company’s service and consumer feedback might also affect the CIBIL score. The higher the CIBIL score is, the lower the interest rates are for small business loans.
#3 Vintage Period of a Business
The vintage period means the total period since the first investment in a business. Small businesses tend to have lesser vintage time since they are relatively new. This can affect the overall interest rate. Most banks prefer companies running for at least three years, and the interest rate reduces with the vintage period. The small business loan interest rates tend to be higher than standard business loans because they have a shorter vintage period.
#4 Profit Margin
Companies with higher profit margins tend to enjoy lower interest rates. Small businesses with promising growth and prospects tend to get loans with low-interest rates. A higher profit margin reduces an organisation’s risk factors and includes any bankruptcy risks. Since most small businesses are only startups and there is no collateral, higher turnovers ensure their prospects. This makes the lender believe in the possibilities of the business. Meanwhile, businesses with lower profit margins are at higher risk categories, so interest rates are higher for any business loan sanctioned.
#5 Government Schemes (Udyam Certificate)
The Indian government has come up with schemes to help small businesses. The Udyam certificate is a document that can be obtained by any small business owner with a GSTIN. This certificate can help reduce the interest rates for small business loan borrowers. Any certificate holder is eligible for a 1% exemption of the interest rate on Overdraft. This is a government-sponsored scheme to help small business owners in India.
All these factors affect the interest rate of small business loans in India. However, financial lenders like Clix Capital remain committed to facilitating small businesses looking for unsecured business loans. They are well-known for offering SME loans starting from 5 Lakhs to 50 Lakhs with minimum documentation, smoother application processes, and quicker sanctions.