Publication details: Money Manager – CNBC Bajar – 02-06-2016

Responses, opinion and view from Kartik Jhaveri.

Debt financing is a very imperative for any businessman. Be it in the inception stage for raising seed capital, or at any moment during the course of the business to fund any major purchases or expansion activities, debt financing becomes the most easily available option to raise money instantly.

Let’s look at the various areas which businessmen need to focus on for raising and managing loans.

1. Firstly, what are the problems which businessmen often face when it comes to obtaining a loan?

  • One of the biggest problems faced is the fact that lenders like banks, are not businessmen. They do not understand the various nuances of a business and hence find it difficult to evaluate the viability of it.
  • Another reason banks find it difficult to evaluate the business financials is because businessmen often do not maintain their books of account properly. This can act like a major setback as it becomes difficult for the lender to put trust in the viability and credibility of the business. This is especially true in the case of unsecured loans.
  • Another problem is that credit score based lending is not freely available… for eg pre-approved funding
  • Most often the small scale businessmen face more problems compared to the bigger businessmen. Most of the time lenders (especially banks) do not entertain their loan requests. It all comes back to inability on the part of the lender to comprehend and evaluate business viability.
  • When money is not available instantly, businessmen fail to take advantage of business opportunity available.
  • Hence it is imperative to strengthen our financial management practices in such a way that we are in a position to grab the slightest window of opportunity and money is available as and when we are in need of it.

2. What are some of the important things to understand about loans? How do they work for businessmen? What is different?

  • Firstly it is important to understand one fact – Banks are not interested in selling your asset (when it is given as a collateral).
  • They are simply interested in earning interest.
  • Lenders like banks and financial institutions are more concerned about what is the business’ net worth and how are its cash flows. They will then be in a position to evaluate the repayment capacity and reliability of the businessman.

3. What are the various sources available with businessmen for raising loans?

Now we shall discuss the pros and cons of each avenue in order of their ease of availability i.e. most instant to least instant.

  • Friends and family
    • Pros – This is the most instantly available source of funds. You know who can lend you money and the quantum of money they can lend you. In majority of the cases this money will be interest free. There might also be a flexibility in the repayment term.
    • Cons – Most often the money will be available as a lumpsum. Hence there are no instalments available. You can expect an on demand payment of the loan amount. Even though it’s family and friends, you need to make sure you repay the loan on time. Better not take the added risk of severing relations.
  • Credit cards
    • Pros – This is the most easy and convenient option.
      • During the normal course of the business, there is always an ongoing need to make various purchases viz. electronics, equipments, furniture, stationery and so on. These needs can be instantly financed with the help of your credit card.
      • The repayment period is in the range of about 15-60 days. Hence you can plan your cash flows and accordingly service your payments.
      • Credit card companies also provide additional incentives and perks in the form of loyalty points for spending using your credit card.
    • Cons –
      • The ease of convenience comes at a cost.
      • If you do not repay on time the interest charged is between the range of 3-3.5% p.m. This be a dampener to the profitability of the business.
      • Also a late payment can hamper your credit score badly
  • Private funding
    • Pros –
      • The money is easily available from industry and private money lenders.
    • Cons –
      • This facility comes at a very high cost.
      • This option is mainly suited for short term requirements as the tenure ranges from 6-12 months.
      • Most often the money will be available as a lumpsum. Hence there are no instalments available. You can expect an on demand payment of the loan amount.
  • Loan against securities
    • Pros –
      • The biggest benefit of this is that it enables you to get instant liquidity without selling your securities. An overdraft facility is advanced by the bank when you pledge your securities.
      • The loan amount would depend upon the type of security pledged. For instance, if you pledge of equity shares & equity mutual funds, then the amount you would be eligible for would be 50% of the value of such shares. This is known as the margin available.
      • There is no time limit to repay. Just keep paying the interest. If the debt is repaid then account is reset to zero and this can be done any number of times.
      • The advantage of pledging your securities (in case of shares) is that you would not be devoid of the benefits as a shareholder. This means that you can continue to enjoy your rights of receiving dividends and bonuses, along with gaining from the upward price movements in shares.
    • Cons –
      • The foremost prerequisite is that you should have a sizeable amount of investments.
      • The valuation of such loans is slightly tricky due to the constant change in value of the securities. The amount of loan given ranges as per the bank’s policy and in accordance of RBI guidelines.
      • If your shares are in demat form, the maximum loan amount is Rs. 20 lakhs… that means collateral of 40 lacs plus. This is as per current guidelines. In case of physical shares it is Rs. 10 lakhs.
      • The ROI charged may vary from bank to bank. In general it varies between 11-15% p.a.
      • LAS account tenure is generally 1 year. This can be renewed by paying a small fee each year.
      • The biggest risk of taking a loan against your shares is that if the share prices continue to fall, the bank may ask you to add additional money to the account, or pledge more shares, to maintain the margin. In a worst case scenario, if you do not have either the money or the additional shares, they may be forced to sell the shares.
  • Overdrafts and Fixed Deposits
    • Pros –
      • Borrowing against you FD can help you get short term money for any kind of financial requirements without breaking your FD. Being a secured loan, the rate of interest is comparatively lower than other personal loans which are unsecured.
      • Generally banks offer a loan of upto 90% of the value of your FD. The interest charged is usually 1% more than your FD rate.
      • Loans against FD can generally be taken for any tenure as long as it does not exceed the tenure of the FD.
      • An overdraft facility is another good mechanism to avail of temporary funding. It is credit line given to an individual against his assets. For example, you can mortgage your house with a bank and get a borrowing limit sanctioned against it. As and when you want you keep withdrawing from your OD account.
      • The ROI generally varies depending upon the collateral. For instance the ROI wherein the property is a collateral is usually in the range of 12-14% p.a.
    • Cons –
      • Overdraft facility is meant for individuals with strong financial discipline. This is because many people tend to misuse the funds. If you use the money for speculative activities like short-term trading in stocks and commodities, it may backfire.
      • If you fail to pay on time, the bank will liquidate the asset.
  • Loan against insurance policy
    • Pros –
      • This option offers you to leverage your existing life insurance policy and generate cash reserves quickly.
      • You do not need to surrender the policy to avail of loan against the policy. Hence it combines to twin benefits of providing life cover and additional funds to cater to immediate financial needs.
      • Also it is best to secure the loan from your insurer rather than approaching a bank to pledge your policy. One reason being there is no risk of your loan request being turned down and another reason is flexibility for repayment period.
      • Generally insurance companies offer loan up to about 80-90% of the surrender value.
      • The ROI charged is about 9-12% p.a.
      • There is no limit on the repayment tenure. Even if you you don’t pay it, the amount will be adjusted with the final value.
    • Cons –
      • This facility is available only on traditional policies, which from a risk management point of view is not advisable.
      • A life insurance policy acquires a surrender value only when you have paid at least 3 annual premiums. Hence you cannot borrow until 3 years of the policy has been completed.
      • Securing your loan from the insurer is preferably if you intend to use the entire amount sanctioned. In case you need the money on and off, you can considering borrowing from banks which offer overdraft facilities against life insurance policies.
  • Personal loans – Banks/Credit cards – Pre Approved
    • Pros –
      • This is a very convenient option to avail funds instantly.
      • The bank will decide the eligibility based on your track record with it.
      • With access to modern services like net banking, availing a loan through this source is just a click away.
    • Cons –
      • You are committed to pay an EMI here.
      • You need to have your net banking services in order to be able to facilitate quick disbursement of money.
      • The loan eligibility depends on the amount of savings maintained with the bank. Hence at times the loan amount may fall short of your needs.
  • Gold loans
    • Pros –
      • It is a quick and hassle free finance option requiring minimal documentation. The disbursal process is quick.
      • The lender (a bank or an NBFC) gives the borrower cash in return for the gold pledged. The RBI has capped the LTV ratio at 75%.
      • The ROI is usually in the range of 12-16% p.a.
    • Cons –
      • If gold prices fall considerably and the pledged gold is insufficient in value to the lent amount, the balance amount will be recovered from the borrower.
      • As far as you are not emotionally to your gold ornaments, this is a good option.
  • Purchase order
    • Pros –
      • This is a very useful option for businesses that have to service multiple customer orders and face cash flow problems.
      • As the bank pays for the cost of your goods directly to the supplier. This frees up your cash for other critical business expenses.
    • Cons –
      • The tenure could be for a short period, say about 45-90 days.
      • The amount is capped at about 60-70% of the purchase order value.
  • Lease rent discounting
    • Pros –
      • This is  good option to obtain financing from a bank or other lending institutes, in case you own a property and have given it on rent. The loan is offered against rental receipts derived from lease contracts with corporate tenants.
      • Generally the borrower does not have to go through stringent credit appraisal norms.
      • The money raised can be used for investments into other properties. If systematically used and prudent norms of leveraging and debt servicing followed, your return on investments can increase significantly.
    • Cons –
      • You cannot sell the property during the loan tenure unless it is fully paid off.
      • Generally the terms and conditions offered by banks are dependent upon the credit rating of the lesse.
      • Compared to loan against property where you can exploit the full value of the property to raise a mortgage, in lease rent discounting only the lease rentals determine how much loan you can avail, which is generally lower than loan against property.
  • Loan against property
    • Pros –
      • This is a good option to explore when the quantum of requirement is relatively large.
      • The property could be a self occupied property, rented residential property, commercial property  or even a piece of land.
      • It is one of the cheapest retail loans (after home loans). The ROI usually ranges between 12-16% p.a.
      • The tenure ranges from 1-15 years.
    • Cons –
      • The amount of loan is generally 40-60% of the market value of the property.
      • You need to have a good repayment track record for other loans, credit cards, etc.
      • Base your decision on your repayment capability as the bank will take possession of the mortgaged property in case of non-repayment.

4. What are some of the pointers to be kept in mind while managing loans?

  • Strengthen your financial behavior – It is very important to maintain financial discipline. Irrespective of the source of loan, you must pay your debts on time.
  • Plan your cash flows effectively so that you can pay your EMIs regularly.
  • Fantastic credit score – By repaying your debts on time and not defaulting at any time, you will be able to maintain a good credit score.
  • Review loan requirement – You must assess the need for taking a loan. Pay attention to the quantum of loan and the amount of EMI. Make sure you are able to bear the burden of servicing the EMIs.
  • Don’t forget to invest – It is equally important to have sizable investments. They go a long way in protecting your financial future. For any of our financial needs, we can fall back on our investments. But we must ensure to replenish our corpus and invest on a regular basis.


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