Types of business loans in India in 2023

Types of business loans in India

Loans are credit facilities that can be offered for different business purposes. In India, the two basic loan types are:

• Secured loans – Business loans with collateral
• Unsecured loans – Business loans without collateral

Secured loans

As can be deciphered from the name, secured business loans are loans that are given to the borrower against a security. This reduces the lenders risks as they have a collateral to back on in case the loan is not repaid in time. The loan amount for these is usually high-ticket, based on the valuation of the collateral, and are often offered at low interest rates.

Example of secured loan: Loan against property

This type of secure loan can be availed when the loan amount requested is high (e.g., greater than ₹2-3 crores). This requires the borrower to pledge a property as collateral against the loan.

Advantages and disadvantages of loans against property:

For a MSME however, this type of bank mortgage loan might not be favourable as they often lack relevant assets to offer as collateral.

Unsecure loans

A more commonly used type of MSME loan is the unsecured business loans or collateral-free loans. As the name suggests, these loans do not require businesses to pledge any collateral against the loan amount and can be borrowed for diverse business functions including working capital challenges, rent or lease property, buy machinery, pay salaries, or any other business operation requirement.

Example of unsecured loan: Working capital loan

These are small ticket loans (up to a few lakhs) that are offered to businesses to meet their daily cash crunches and working capital needs. These usually do not require any collateral and are approved based on the credit score and financial health of the business. Working capital loan financing is often availed by MSMEs (e.g., traders, retailers, etc.) as it helps them to meet immediate cash requirements and manage regular operational expenses especially during lean seasons.

4 types of loans for your business

As you have gathered by now, there are different types of MSME loans that you can avail for your business. Based on the lender, the loan amount, and the type of business loan you are availing, it can be secured or collateral-free.

Listed below are some of the popular loan types that MSMEs avail for their business. These funds are offered for specific business needs and have additional loan documents requirements. It is advisable to check with the bank for details.

Commercial vehicle loan

Also known as fleet finance, these are business loans offered to purchase commercial vehicles – either new or pre-owned. These loans can be availed for purchasing trucks, buses, tempos, water tankers, etc. and other commercial vehicles. You can be an existing fleet/transport operator or a first-time buyer to avail these loans.

Most banks in India offer commercial vehicle loans with varying interest rates and EMI options, based on the type of vehicle purchased and the automobile manufacturer.

Some of the key points to keep in mind when availing commercial vehicle finance are:

• These loans can be availed as a new loan, refinancing option, or top-up loan (check with the bank offering the loan)
• Electric Vehicles (EV) and CNG vehicles for commercial use can also be purchased using these loans (offered by selective banks/NBFCs)
• Bank loan interest rates are low, loan amount varies (usually up to ₹50-60 lakhs), repayment tenure depends on the type of commercial vehicle purchased (usually 3-4 years), and EMI payments can be negotiated

Processing fees, service charges etc. are also added – so it is advisable to check all details before availing these loans.

Short term business loan

Offered by most Indian banks and NBFCs, these loans are designed for MSME businesses to access funds for the short term. These are usually unsecured loans as the amount offered is less and for a short duration only (usually up to 12 months). Businesses can get small term business loans for business expansion, to meet daily operational needs, buy inventory, pay rent on property, spend on marketing activities, etc.

Short term finance is often favored by small businesses as the loan:

• Is disbursed within a few hours (usually 48-72 hours based on documents submitted)
• Can be used for immediate business needs and be repaid within a few months
• Requires no collateral to be kept as security
• EMI amount and tenure can be decided by the borrower (up to 12 months)

Alternatively, you can also try and explore government schemes for small businesses for short term loans. There are several loan options available that provides MSMEs with funding to meet their diverse business challenges.

Machinery loan or equipment finance

Several banks (public and private) and NBFCs provide machinery loans for MSMEs to purchase and/or upgrade equipment and machines for their manufacturing unts, factories, and production requirements. Considering the need for businesses to automate processes, many MSMEs have realised the benefits of using advanced machinery in production to reduce errors, maintain quality, and bring agility and efficiency.

Equipment financing is often availed by MSMEs to:

• Buy high-cost machinery, repair or upgrade old machinery
• Keep the machines purchased as collateral along (Note: Some banks may request for additional security if the loan amount is high)
• Automate production processes for efficiency, reduced errors, and quality control

Since the equipment purchased is mortgaged with the bank, the loan interest rates are usually low (i.e., as less as 10-12% of asset cost), the tenure can be longer (i.e., 3-7 years), and the loan amount higher (i.e., up to ₹2 crores with additional collateral).

It is recommended that as a business owner, if you are keen to avail business loans on machinery, check with the bank/NBFC on their offers and terms.

Invoice financing

Invoice financing is another popular business loan type for small businesses in India. It steps from the situation that there is often delay in receiving payments from customers against invoices generated. Lack of cash can put small businesses in a difficult situation especially when daily operational expenses must be met.

Invoice financing (often also called invoice factoring) involves banks/lending institutions offer loans against the invoice amount. In general, the loan amount can range between 80-90% of the invoice.

Invoice discounting is one of the most preferred forms of borrowing for MSMEs. Today, there are invoice or bill discounting programmes that can enable MSMEs to gain access to cash earlier than the due payment date.

Some key points to keep in mind about invoice financing are:

• Not all banks offer invoice finance nor are all invoices eligible for it
• You get paid early at a small, discounted rate to meet operational and working capital needs
• There may be additional fees involved including bank service charges
• Factors like the value of the invoice, business’s financial health, ongoing projects, pending payments, etc. will affect the loan offered

Finding the right kind of business funding for your MSME

There are different kinds of loans available in the market today for SMEs. There are business loans and MSME loans, government loan schemes, special term loans for start-ups, loans for women entrepreneurs, and more that you can avail based on your needs.

Ideally, when selecting the type of loan, identify why you need the loan. Banks/NBFCs check the borrower’s profile before lending, so ensure your business’s financial statements and related documents are in place. You should also check with the bank on the loan type recommendations and seek end-to-end information before availing the loan.

(This article was originally published in Feb,2023 and updated on June 2023 for relevancy)