Types of Business Loans in India - Definition, Pros & Cons

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When entrepreneurs seek to fuel their dreams and support the growth of small businesses, it's crucial to know the diverse range of loan types available for businesses. In India, you can find a rich tapestry of loans that aligns with your business goals and stands ready to address the distinctive financial requirements of various enterprises. These options are the lifelines that keep entrepreneurial aspirations thriving.

From traditional bank loans to innovative government-backed schemes, this guide will explore the types of business loans in India, helping you make informed decisions to support your business dreams.

Broadly, there are 8 Types of loans available for business in India

Here are the 8 most common types of loans available for business in India:

1. Working Capital Loan

A working capital loan is a business's financial lifeline, primarily intended to fund day-to-day operations, encompassing accounts payable, employee wages, and other immediate financial obligations. These loans can be secured or unsecured, depending on the company's financial health and required loan amount.

It's essential to note that a working capital loan is not intended for capital asset purchases or expansive business ventures. Instead, it meets short-term financial commitments and sustains daily operational expenses.

Pros

Working capital loans offer debt financing without necessitating equity transactions, helping businesses bridge gaps in their working capital expenses.
Some are unsecured, eliminating the need for collateral.

Cons

These loans may entail higher interest rates linked to a business's credit profile.
Any missed payments can adversely affect the business's credit score, as well as the personal credit score of the borrower.

2. Term Loan

Term loans are among the most common types of business funding. These loans can be secured or unsecured, with the amount available often contingent on the business's credit history.

Borrowers receive a lump sum of capital upfront, repayable with interest over an agreed-upon period. Unsecured term loans generally span one to five years, while secured term loans can extend up to fifteen or twenty years.

Pros

Term loans provide immediate access to cash, often in more significant amounts than other business loan types.
They feature quick fund disbursement and predictable repayment schedules.

Cons

Repayment schedules can be inflexible.
Collateral may be required for secured term loans.

3. Letter of Credit

A letter of credit serves as a financial safeguard in international trade, assuring buyers and sellers that transactions will proceed smoothly. This credit instrument is especially important when dealing with unfamiliar suppliers in foreign markets.

4. Bill Discounting

Bill or invoice discounting allows businesses to access immediate cash flow by selling their unpaid invoices to a lender at a discounted rate. This type of business financing benefits sellers by accelerating cash inflow and, in turn, aids lenders in generating revenue through interest rates levied on buyers.

5. Overdraft Facility

An overdraft facility, offered by banks to account holders, permits withdrawals even when account balances hit zero. Interest accrues on the utilised amount from the approved limit daily. They can be secured by collateral, often as Fixed Deposits (FDs) with the bank.

Pros

It boasts minimal paperwork, providing flexibility in managing fund shortfalls promptly.
Interest is calculated solely on the amount of funds used, reducing overall borrowing costs.

Cons

Overdrafts are temporary loans, and credit limits may be adjusted.
They are secured against collateral, potentially leading to asset seizure in the event of payment defaults.

6. Machinery Loan

Machinery and equipment finance loans provide funding for acquiring or enhancing machinery and equipment. It is generally used by large manufacturing companies, this financing option offers tax benefits.

Pros

Swift access to funds for equipment purchase, repair, or leasing.
Cost spreading to prevent cash flow challenges.
No additional collateral is required.

Cons

Limited to equipment/machinery-related expenses.
Higher interest rates compared to traditional bank loans.

7. Government Loans

The Government of India has launched various loan schemes to promote MSMEs, individuals, women entrepreneurs, and entities in the services, trade, and manufacturing sectors. These schemes are extended through public and private sector banks, Regional Rural Banks (RRBs), NBFCs, Small Finance Banks (SFBs), Micro Finance Institutions (MFIs), and more. For example, Mudra Scheme under PMMY, Standup India, CGTMSE, Startup India, etc.

Pros

Government-backed for added security.
Low interest rates.
Relatively low down payment options.

Cons

Highly competitive application process.
Strict guidelines in specific programs.
Personal guarantees, including commercial property, may be required.

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

Merchant Cash Advances (MCAs) or POS Loans involve businesses receiving an upfront lump sum from suppliers in exchange for a portion of their daily or future debit and credit card transactions. Merchants often turn to POS loans to alleviate liquidity challenges, though they come with higher interest rates than other business loan types.

Pros

Instant cash flow management.
Simple repayment process with minimal documentation.

Cons

High-interest rates compared to traditional loans.

Read Also: Benefits of Small Business Loan

Conclusion

In India's diverse financial landscape, various business loan types cater to the financial needs of enterprises. From traditional term loans to innovative government-backed schemes, these funding avenues empower businesses to thrive. While each loan type has pros and cons, they collectively foster growth, create opportunities, and fuel economic progress.