Business Loan Eligibility Criteria
Business Loan Eligibility Criteria
Bank loan is a very good option for a lot of Entrepreneurs starting a business in the traditional business in the areas of service / manufacturing / trading. Though there is a lot of interest and excitement around angel or private equity funding in the recent years, bank loans still continue to fund the most number of businesses in India. With a strong banking system and network of lending Non-Banking Financial Companies (NBFCs), an Entrepreneur can easily obtain business loan for a startup. In this article, we look at some of the main criteria business loan eligibility criteria.
Scheme or Product Fit
Unlike equity funding, banks have a strong structure and mechanism for approving or rejecting bank loan sanctions – based on various parameters. Therefore, prior to applying for a business loan, the Entrepreneur must make him/herself familiar with the schemes available in the bank for business loan and apply for the right one. For instance, many banks operate a MUDRA Loan Scheme, a scheme for providing unsecured business loan of less than Rs.10 lakhs for new Entrepreneurs. A new Entrepreneur applying under such a scheme will likely have higher chance of success than applying for a scheme under which the Entrepreneur does not meet the banks criteria for lending.
Bankers follow specific procedure while processing loan applications and require a certain set of documents for processing a bank loan proposal. Therefore, to even be considered for a bank loan, the Entrepreneur must compile and submit to the Banker good documentation. The following are some of the documents required for processing of a business loan application:
- Financial Projection
- Financials presented in CMA Format – Credit Monitoring Arrangement Format
- Business Loan Request Letter
- Certificate of Incorporation (If Company / LLP)
- Partnership Deed (In case of Partnership Firm)
- PAN of the Promoters / Directors / Partners
- Address Proof of the Promoters / Directors / Partners
- MSME / Udyog Aadhaar Registration (if available)
- VAT Registration / Service Tax Registration
- Copies of IT Return of the Promoters (if available)
- Bank Statement of the Promoters
- Valuation of Collateral Property (if applicable)
- Legal Opinion for Collateral Property (if applicable)
- Assets & Liabilities Statement of Promoters (if applicable)
The above list is indicative only. The Banker at his/her discretion might request for more or lesser information based on the credit profile of the bank loan applicant. Further, submission of the above documents do not ensure sanction of the loan. The above documents must be submitted and the credit opinion would still be taken by the Banker based on a various of factors.
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Profit & Cash Flow
Unlike angel or equity funders, bankers look for profit and positive cash flow to lend. Bankers do not get equity of the company and are eligible only to receive interest on the funds loaned. Hence, Bankers would not take into consideration the long-term profitability / positive cash flow of the business – projected to be generated in the future. Bankers will tend to only fund proposals that have profitability and positive cash-flow, after the initial setting up period. Therefore, as a borrower, you must show that the business performance is positive and that operation are not only profitable, but also generate sufficient cash to cover all financial commitments.
Promoters Contribution or Margin
To avail any loan, the promoter must have and must invest the Promoters Contribution or Margin. Banks do not lend 100% of the funds required for investment in equipment or working capital. Hence, the promoter must have funds available to meet the margin requirements stipulated in the loan conditions. For instance, if an Entrepreneur wants to purchase a machinery worth Rs.10 lakhs, the Bank would sanction an equipment loan with margin of 20% (assumed number). In this case, the bank would provide loan of Rs. 8 lakhs and the promoter would have to invest his/her funds worth Rs. 2 lakhs to purchase the machinery. Based on the nature of the loan and the requirements of the Entrepreneur, margin requirement can vary anywhere between 50% – 10%.
Most business loan schemes provided by banks require a primary security to be created from the funds provided by the Banks. In case business loan is availed for machinery, then the machinery purchased would be termed as primary security. In case business loan is availed for working capital (i.e., raw material or stocks), then the primary security would be the raw material or stocks or receivables. In case of default in loan payments, the Banker would have the rights to hypothecate the primary securities and sell to recoup losses.
Banks tend to prefer projects wherein strong primary collateral is created, which can be easily hypothecated and sold by the Bank. For example, a large machinery would be considered a strong primary security, whereas interior decorations maybe considered a weak primary security – as it cannot be easily taken and sold.
In addition to primary security, which by default would be hypothecated by the Bank, Bankers also tend to request borrowers to provide collateral security. Collateral security in the form of residential property or commercial property are preferred by Bankers. Agricultural property cannot be accepted by Bankers as collateral security – as agricultural property be auctioned off under the SARFESI Act. There are various unsecured business loan schemes; however, providing strong collateral security would tremendously increase the chances of obtaining bank loan.
In addition to the above criteria’s, Banks also provide weightage to the promoters age, education, experience, expertise and background. While there are no set rules, Bankers typically tend to prefer Entrepreneurs with good experience and expertise with the business for which loan is requested.
Bankers look for a blemish free track record of loan repayment while sanctioning bank loan. Bank statement of upto one year and CIBIL score would be checked by the Banker prior to sanctioning of any loan facilities. In case of any cheque bounce or low CIBIL score or repayment defaults, the chance of obtaining bank loan can be severely degraded. Thus, it is good for loan applicants to check their CIBIL score periodically – especially if they are about to apply for bank loan.
For help preparing a business plan or bank loan application, talk to an IndiaFilings Business Advisor.
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