While the driving force behind all businesses is an increased bottom-line, entrepreneurs cannot deny the role of capital investments in determining the success of their businesses. From raw material, production equipment, salaries and wages, packaging and logistics, to operational expenses such as office space, stationery and electricity bills – you need capital to take care of your daily operations. Capital funds can be generated either from your own sources or by taking a loan from banks and other financial institutions.
However, if you have no capital backup, you need to be aware of the kinds of loans that are available in the financial market, and the challenges that come with them. For starters, it’s imperative that you know the distinction between secured and unsecured business loans.
Secured Business Loans
Secured loans are always backed by an asset whose value is equal to or more than the value of the loan borrowed. In case of a bad debt, the loan can always be recovered by the bank or financial institution by claiming this asset.
But what if a business has no collateral to get a loan? Even so, you have the option of exploring unsecured business loans.
Unsecured business loans are loans that are borrowed without any collateral or business asset as backup. Rather, they are given by banks based on the repayment capacity of the borrower’s business. This is calculated by the creditworthiness of the enterprise. Unsecured business loans are mostly short term in nature.
There are several impediments involved in getting an unsecured business loan. Little wonder that these concerns render them less friendly as compared to secured business loans. Here are five challenges faced by most entrepreneurs while trying to get an unsecured business loan:
- High interest rates
Any loan attracts a certain interest rate depending on the requirement for the loan. For unsecured business loans in India, the interest rates vary from a steep 18% – 22%, as they don’t ask for any collateral to be given. While this could be a justified expectation on the bank’s part, it can prove to be a risky business deal for you. The repayment also tends to be quite challenging, as these need to be made within a short tenure. This, in turn, means that the EMI may also be higher than that for secured loans.
- Low credit score
Credit scores are generated on the basis on your track record in repaying debts. This is built across time and you need to make your payments on time without ever faltering on the payment dates to increase your credit score. A good credit score will ensure you get an unsecured loan easily from a bank or a Non-Banking Financial Company (NBFC). However, a bad credit history will act as a roadblock to getting unsecured business loans. Keep an eye on your credit score and find ways to improve it as and when possible. There are a few techniques to improve your credit score which can come in handy when applying for a loan. Do your research and increase your credit score for unsecured loans. Since these loans are provided without any collateral, credit scores become an important eligibility criteria that must not be ignored at any point in time.
- Growth of the business and personal experience of the entrepreneur
The growth of a business is an important aspect that banks and financial institutions keep in mind when considering your application for an unsecured business loan. A few of the lending bodies decide the amount of loan depending on the average profits earned in the last few years. You may also provide your business projections to banks and lending institutions for consideration. This works towards increasing your chances of securing a higher loan amount. Unsecured business loan interest rates depend on the experience you carry, as this will decide the return of the loan amount. If you have a fool-proof business expansion plan and need a loan to fulfil it, you need to use an unsecured business loan. Trying to get secured loans with specific collaterals at this point may become an uphill task for you.
- Rigid bank policies
Banks and financial institutions formulate policies that help them to maintain their annual profits. These bank policies for unsecured loans may not be the most business-friendly ones. Most banks do not sanction unsecured business loans as they lack the necessary risk-taking capacity. If you wish to take an unsecured business loan, it is always advisable to approach a lending company which will help you get the loan at an affordable interest rate and without requesting any collateral.
- Eligibility criteria
There are eligibility criteria for unsecured loans that you need to be aware of before you go ahead and apply for the loan. So, complete your homework for the required paperwork, and only thereafter approach a bank or financial institution for an unsecured loan. The two main eligibility criteria to avail an unsecured loan are: a) four years of continuous business operations in the same industry and b) a minimum turnover of Rs 1 crore. If both criteria are fulfilled, getting an unsecured loan for your business is relatively easier.
Work towards overcoming these impediments and you can be better prepared when applying for an unsecured business loan in India.