Types of Business Loans

A loan specifically intended for business purposes is known as a business loan. Business loans provide business owners with financing either as a credit line or lump sum payment. In exchange for this funding, businesses agree to repay the loan over time, plus interest and fees. Continue scrolling to learn about the different business loan types available in India and their pros and cons. The right business loan for your business depends on what you need the money for and when you need it.

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8 Types of Business Loans in India:

1) Working Capital Loans

working capital loan is a loan to fund an enterprise’s day-to-day operations, ranging from covering accounts payable to payment of employees’ wages. Such loans might be secured or unsecured, depending on the business’s financial health and the loan amount.

Note that a working capital loan is not meant to fund asset purchases or business expansion plans. It is a business loan to meet short-term financial obligations, operational requirements and day-to-day business expenses. It typically comes with a loan tenure ranging from six to forty-eight months. However, the tenure may vary from bank to bank.

Pros:

  • It is a type of debt financing and doesn’t require an equity transaction
  • Allows businesses to cover their gaps arising in working capital expenses
  • Some working capital loans are unsecured, and there’s no need for businesses to keep collateral for securing the loan

Cons:

  • Working capital loans typically have higher interest rates
  • The loan is attached to the business’s credit, and any missed payments result in impacting the credit score of the business and your personal credit score

A working capital loan is best for businesses seeking to cover day-to-day operational costs. They are ideal for seasonal businesses and small business owners who need an occasional cash infusion to stay afloat and maintain business cash flow.

2) Term Loans

The most common type of business finance is a term loan. It can be unsecured or secured, and the amount available depends on your business’ credit history. Borrowers get a lump sum of cash upfront, which will be repaid with interest over an agreed period. If the term loan is unsecured, the tenure will range between one and five years. Secured term loans can go up to fifteen to twenty years.

Term loans are generally applied for a specific purpose, such as capital expenditure.

Pros:

  • Businesses get cash upfront
  • Typically allows businesses to borrow a higher amount than other business loan types
  • Quick fund disbursal in lump sum amount
  • Predictable payment schedule

Cons:

  • Inflexible repayment schedules
  • It may require a collateral

Term loans are best for businesses looking to expand and ideal for business owners with a good credit history who do not want to wait too long for funding.

3) Letter of Credit

different types of loans

A letter of credit is a type of credit limit used in trading businesses in which lenders or banks provide funding guarantees to organisations that deal in international trade. It can be used for export and import purposes by business owners.

Companies doing business overseas have to deal with unknown supplies; for that, they need assurance of payment before proceeding with any transaction. A letter of credit plays a critical role in providing payment assurance to the suppliers.

Pros:

  • A letter of credit is highly customisable and allows both trading partners to put in their terms and conditions.
  • It gives trade partners the confidence to transact with unknown partners or establish a new business overseas.
  • The issuing bank or lender is independent of the trading partners’ obligations, and the seller receives the money after fulfilling the terms.
  • The seller is free of credit risk.
  • Typically unsecured, so collateral is not required

Cons:

  • Bank fees and other processing charges result in adding to the cost of doing business
  • The formalities are time-consuming
  • A letter of credit has complicated governing rules, and it also carries forex risks

A letter of credit is best for businesses trading in the international markets and hoping to expand.

4) Bill Discounting

Bill or invoice discounting is a funding facility in which the seller gets an amount in advance at discounted rates from the lender. The buyers are asked to contribute interest rates to enhance the financial institutions’ revenue.

Pros:

  • Get fast cash
  • Release cash that has been locked in invoices
  • A faster way to take short-term finance
  • No risk to assets and boosts credit sales

Cons:

  • Borrowings are allowed on commercial invoices only
  • Bill discounting might not be adequate if businesses are seeking a particular amount of business loan

Bill discounting is best for businesses hoping to rejuvenate their cash flow, fund business expenditure and stabilise growth.

5) Overdraft Facility

An overdraft facility is a type of funding offered by banks to their account holders to withdraw cash from their accounts even when the account balance is zero. The interest rate is charged on the utilised amount from the approved limit and daily. An overdraft facility is offered against securities/collateral, especially regarding FDs with the bank.

The sanctioned credit limit depends on the account holder’s relationship with the bank, cash flow, credit history and repayment history, if any. The credit limit is revised every year and can be used in any manner if the interest is paid on time.

Pros:

  • Minimal paperwork and flexibility
  • Helps in handling mismatch of funds promptly
  • Less interest rate as it is calculated only on the amount of funds used

Cons:

  • An overdraft facility is a temporary loan, and there’s the risk of a reduction in credit limit.
  • It is offered against collateral/securities, and businesses risk having the assets seized if they fail to meet payments.

An overdraft facility is best for businesses facing frequent short-term cash flow problems but can repay the borrowed amount in a very short period of time.

6) Equipment Finance or Machinery Loan

The machinery or equipment finance loan is a funding option offered to borrowers for them to buy new machinery/equipment or upgrade the existing one. It is majorly used by large companies engaged in the manufacturing sector in need of equipment financing. Business owners or organizations availing of machinery or equipment loans enjoy tax benefits. The loan amount, interest rate, and repayment tenure vary from lender to lender.

Pros:

  • Quickly receive money to purchase, repair or lease equipment/machinery
  • Opportunity to spread the cost of the purchase to avoid running into cash flow problems
  • Additional collateral is not required for equipment loan

Cons:

  • Usage is limited to equipment/machinery
  • Machinery loans offer a higher rate of interest than traditional bank loans

Equipment finance or machinery loan is best for large enterprises belonging to the manufacturing industry in need of funds to purchase machinery or equipment.

7) Loans under Govt. Schemes

different types of government loans

The Government of India has initiated several loan schemes to encourage and promote MSMEs, individuals, women entrepreneurs and other entities engaged in services, trading and manufacturing sectors. These loans are offered by different financial institutions like public and private sector banks, Regional Rural Banks (RRBs), NBFCs, Small Finance Banks (SFBs), Micro Finance Institutions (MFIs), etc.

Some top Government Loan schemes include PMEGP, Mudra Scheme under PMMY, PMRY, Standup India, CGTMSE, PSB Loans in 59 minutes, Startup India, etc.

Pros:

  • Backed by the Government of India
  • Interest rates are low
  • Relatively low down payment options

Cons:

  • The loan application process is highly competitive
  • Certain programs provide strict guidelines on how businesses must spend the approved amount
  • Personal guarantees are required, such as your commercial property

Loans under Government Schemes are best for startups and existing businesses wanting to expand. These loans provide business owners easy access to funds to convert their bankable business ideas to profitable ventures.

8) Point-of-Sale (POS) Loans or Merchant Cash Advance

Merchant Cash Advances or POS Loans is a mechanism in which businesses pay a lump sum amount in advance to suppliers through their daily or future debit or credit card transactions.

Merchants opt for POS loans to reduce liquidity crunch in the business. The interest rate offered under POS loans is higher than other types of business loans. The repayment facility is linked with credit or debit transactions POS machines installed at grocery stores, retail shops, shopping malls and supermarkets. Borrowers can easily pay interest and repay the loan.

Pros:

  • Instantly manage cash flow issues
  • Easy repayment facility and minimal documentation

Cons:

  • High interest rate

POS loans are best for businesses that need to pay a lump sum amount to suppliers in advance and need funds to overcome the cash flow crunch.

While these are the primary types of small business loans, there are other business loans available on the market. You need to discuss your requirements with your chosen financial institution to make an informed decision.

What is Cash Credit Facility?

A cash credit facility is loans granted as overdrafts on stock security in raw materials, trade and process. It is secured by the pledging of the enterprise’s current assets (receivables and inventory).

The limits of cash credit are based on the drawing paper, which is established after deducting the margin that the bank or lender over stocks fixes. The outstanding balance is less than the drawing power.

The tenure of the sanctioned loan expires every year, and it has to be renewed after twelve months. The duration is calculated from the loan’s approval date to the date on which the twelfth month falls.

What is Bank Guarantee?

Bank Guarantee is the word given to the debtor by the bank that all the liabilities will be taken care of if the debtor fails to fulfil the contractual obligations. The different types of Bank Guarantee are:

  • Performance Guarantee
  • Bid Bond Guarantee
  • Foreign Bank Guarantee
  • Advance Payment Guarantee
  • Deferred Payment Guarantee
  • Financial Guarantee

The tenure depends on the guarantee requirement.

How to Apply for a Business Loan?

Business loans are offered by financial institutions, such as banks and NBFCs. It can be easily applied online. Business owners must find a lender that suits their business requirements and needs and apply for a business loan. One way to do this is by visiting the official website of the lender or bank and filling out an online application form for a business loan. If the bank or lender considers you eligible, you will get the loan soon.

Alternatively, you can register on the Yubi Loans platform to quickly access funds at competitive interest rates and meet online lenders, along with banks and NBFCs. On this platform, businesses can connect to more than 750 lenders, interact with them and go through details, such as eligibility criteria, loan amount, repayment tenure, interest rates, etc. Businesses need to select their business loan type that fits their requirements and choose the lender to disburse the loan amount in three clicks.

Documents Required for Applying for a Business Loan

The documents required to apply for a small business loan or are:

  • Identity proof like driving license, passport, voter’s ID, PAN card, etc.
  • Latest Income Tax Certificate.
  • Statement from the bank regarding your bank account.
  • Address proof like electricity bill, trade license, ration card, etc.
  • Audited financials for the past three years.

Top of Business Loan Providers in India

The best banks for a business loan in India are:

  • HDFC Bank Business Loan (avail loan up to Rs. 40 lac without collateral or guarantor, repayment period of 12 to 48 months and interest rates range between 12.75% to 21.70% p.a.)
  • Axis Bank Business Loan (get a loan of Rs. 50 lac without any collateral or mortgage, a maximum tenure of 36 months is provided, and the rate of interest depends on past track records and business financial assessment)
  • ICICI Bank Business Loan (get an overdraft facility under this scheme, no need for a collateral or guarantor, get a loan up to 2 crores, and the interest rate falls between 16% to 22% p.a.)
  • Kotak Business Loan (get a loan starting from Rs. 3 lac to Rs. 75 lac, the repayment tenure is 48 months, and the interest rate is between 18% to 23% p.a.)

Besides banks, other top business loan providers in India are Fullerton India, Au Financiers and Magma Fincorp.

FAQs

There are eight different types of business loans available in India for small business owners, medium business owners and large business owners. These are working capital loans, POS loans, overdraft facilities, loans under government schemes, equipment finance or machinery loan, bill discounting, letter of credit and term loans.

The best loan for a business depends on the business requirements, the needed loan amount, the reason for seeking a loan and the repayment ability of the company. Also, businesses must meet the eligibility criteria for the loans offered by banks and NBFCs. Business owners can check their eligibility by registering on the Yubi platform and connecting with different lenders providing long and short term loans.

The most common type of business loan in India is a term loan. The loan can be unsecured or secured in nature. The amount available depends on the credit history of the existing business.

The tenure is fixed, typically between one to five years if the loan is unsecured. For secured business loans, the tenure can go upto fifteen to twenty years.