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Business loan or working capital loan? What do you think works best for MSMEs? To understand what the best choice is, one needs to know what are business loans and working capital loans and how they are different. This article explains the definition of a business loan and a working capital loan, difference between them and how to choose a right one for your business.
What is a business loan?
A business loan is a credit facility that can be obtained for business purposes such as buying high-cost machinery or fulfilling other operational needs. It is essentially a term loan that is offered with the defined repayment schedule based on tenure, interest rate, borrowed loan amount and other factors. There are several types of business loans available in India such as secured loans, unsecured loans, commercial vehicles loan, machinery loan, invoice financing, etc. Business loan can be obtained with or without collateral.
You can approach any bank for NBFC (non-banking financial company) to avail a business loan.
Alternatively, Tata nexarc offers unsecured business loans for MSMEs at competitive rate of interest. The process for applying for the same is completely online and you can get a loan offer in as less as 5 minutes!
What is a working capital loan?
It is a type of a business loan that is specifically given for the purpose of meeting requirements of working capital. It is usually a short-term loan with no collateral requirement. The loan amount offered is also lesser as compared to a business loan.
Since in general working capital loans are offered for shorter duration and without collateral, not all banks and lenders offer them as risks are higher. As a borrower looking to get working capital loans for your business, it’s advisable to check with your lender if the loan type is offered. If not, you can always try for a collateral-free business loan and use it to meet working capital needs.
Key differences between business loan vs working capital loan
- Purpose: Working capital loan is specifically provided for meeting needs of working capital shortage. On the other hand, a business loan can be provided for meeting varied business requirements including technology upgrades, purchase of new commercial vehicles, etc.
- Loan amount: Loan amount of working capital loan is usually lesser than other business loans. Usually, it ranges from ₹50,000 to ₹30 lakh. On the other hand, business loan amount is much higher. Depending on purpose, it can be up to ₹30 crore or more. Usually, cost of the investment that the company is trying to make determines the loan amount for the business loan. For small business loans, in general, lenders prefer to limit the loan amount to ₹2 crore to minimise risks and reduce defaulting EMI repayment.
- Collateral requirement: Generally, working capital loan does not require any collateral while business loan may or may not require collateral. For example, if you are buying a new commercial vehicle worth ₹30 lakh, the same vehicle would be promised as a collateral in commercial vehicle loan. Alternatively, business owners also promise other assets such as property as a collateral for business loan. It is however recommended that personal properties are not pledged as collateral as defaulting could lead the lender liquidating it to recover funds.
- Interest rate: Working capital loan attracts higher rate of interest because there is no collateral involved and the loan tenure is lesser. Conversely, business loan that involve collateral and are taken for longer duration, has lower interest rates. Note – When borrowing, also ask the lender about other fees and charges such as processing fees, documentation charges, prepayment charges etc. This will help you calculate the actual amount.
- Ease of paperwork: Documents required for working capital loan are fewer. Aadhaar card, PAN card, bank statement, address proof, credit score etc., are some of the documents that are required for the working capital loan. However, business loans require more documents. As collateral is involved, documents related to the promised property/machinery/vehicle need to be submitted apart from the KYC documents.
- Time for disbursement: There are certain loans (e.g., PSB Loans in 59 minutes) where loans can be approved within an hour. It takes a few days for documents verification and processing for a working capital loan. On the other hand, processing of business loans is a lengthier process. In case of collateral involvement, a visit from bank official for verification also needs to be considered.
Which financing option is better?
Business loans come with varied interest rates, durations and benefits. There are loan schemes for start-ups, for women entrepreneurs, for entrepreneurs and so on. As a result, though challenging, it is important to identify the right kind of loan for your business. Here are some tips that can help you opt for a right loan scheme for your business.
- Define your purpose: Firstly, define the purpose behind seeking loan. Are you short of working capital? Do you want to make a new investment in plant and machinery? Do you need funds for launching a new product? Once you define the purpose, it is easy to seek right loan scheme for your business.
- Loan is not the only option: Funding can be availed through various options. Loan is not the only option for funding your business needs. Many SMEs are opting for IPO. You can check your SME eligibility for IPO and explore that option too. Additionally, the government of India encourages MSMEs growth by launching various schemes. For example, the government has a scheme for enabling technology upgrades for MSMEs.
- Make a business plan: Once you analyse your business needs and decide to opt for a loan, make a robust business plan. This will help you to get a quick approval for your loan.
- Approaching banks and NBFCs: Once you know the purpose for obtaining a business loan, it will be easier for you to get in touch with banks and NBFCs. For example, if you need a loan for buying a commercial vehicle, you can enquire about loans especially designed for the purpose and apply for the same. Approach few banks and NBFCs, learn about their terms and conditions and accordingly shortlist some to apply for a loan. Alternatively, you can also apply for a loan online.
Business loans and working capital loans are essentially a form of term loan, meaning it has a fixed repayment schedule based on the loan amount, interest rate and other criteria. As a borrower, it is advis’able to first understand the details of the borrowed sum and even negotiate a loan repayment strategy to ensure that you are getting the best loan offer.