Do you know the pros and cons of taking a business loan?

Business loans can give entrepreneurs the financial fillip they need. However, before you take one, here are some pros and cons that you should know about.

Do you know the pros and cons of taking a business loan?

Lakhs of small businesses – from kirana stores to traders to MSMEs and SMEs that form the backbone of the Indian economy – rely in some way or the other on loan assistance from banks, NBFCs, and even government-funded institutions. A business loan is a simple, easy to secure, and cost-effective option to raise money. If you are an entrepreneur looking for funding, here are some pros and cons that you should consider before applying for a business loan.

Pros:

Fast-track your business goals

Whether you are looking to scale operations, buy new equipment, hire more people, or undertake a marketing campaign, it will require a significant capital allocation. The required funds are usually not readily available with fledgling businesses. A variety of generic and specific business loan products such as start-up loans, overdraft facilities, bill discounting, working capital loans, micro-financing schemes (Mudra, CGTMSE, etc.) are now available that allow you to accelerate your growth prospects, remain competitive, and attract new customers for your business.

Mitigate cash flow challenges

Extended credit cycles, delayed payments from customers, equipment breakdown, or sudden economic changes like the COVID-19 pandemic are some of the anticipated issues that can bring your productivity to standstill. On account of swifter credit assessment and standardised underwriting procedures, you can get in-principle loan sanctions within hours and receive the credit in your account within 48 hours. Minimal documentation and simplified procedures ensure that the turnaround time on loans is minimised, thereby providing timely capital.

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Do away with collateral or guarantors

A majority of financial institutions now offer unsecured business loans that do not require you to present a personal or business asset as a guarantee, or bring on other people as co-signers for the loan in lieu of a repayment surety. These new-age business-friendly loans are a boon to new and small entrepreneurs that do not have the assets or business experience to avail of secured loans. These loans are approved based on the credit assessment of the primary applicant, viability of the business plan (for new start-ups), and financial statements, among other parameters.

Avail of convenient repayment options

Business loans are available with convenient repayment terms. You can structure your EMI and tenure based on your anticipated cash flow projections, thereby reducing the financial and mental strain of servicing the loan. Most business loans are available for tenures ranging from 12 to 60 months. You should understand the various amortisation schemes and use a business loan calculator to figure your optimum repayment scheme. What’s more, the interest paid towards a business loan can be claimed as deduction, which helps to reduce your tax liability.

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Cons:

Eligibility is based on your credit score

Unsecured loans generally tend to be more expensive than secured loans, as they carry a higher risk for banks and NBFCs. The borrower does not provide any collateral that can be liquidated in case of default. So, lenders charge a premium on such loans. Another critical factor that affects the cost of borrowing is your credit score. If you have an insufficient or poor credit history, your loan will get a lot more expensive, if you qualify for them. A credit score of 750+ is generally considered a benchmark for assessing eligibility. Ensure that you have no outstanding credit card dues and a healthy repayment history for other loans so that you get favourable terms on your business loan.

Loan amount may not be sufficient

Financial institutions prefer giving out small unsecured loans to more businesses than large sums to a few. They are wary of disbursing large loans because of the risks associated with unsecured loans and the lack of recoverable assets. While such loans can be invaluable for short-term needs, you will not be able to utilise such a loan to deploy large-scale strategies, such as business expansion to new locations, CapEx growth, or large-scale product rollouts.

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Liquidity is often constrained

High interest and long tenures on loans can drain your cash flows and limit your ability to make dynamic business decisions on account of the liability. For many small businesses it also means they cannot get additional loans until they scale up or repay the existing loan, due to the exposure the bank or NBFC has already taken with a new enterprise. So, it is important that business owners think carefully about the need for a loan, its use, and their repayment strategy so that the loan does not become a burden.

Last words

As with any source of financing, there are both advantages and disadvantages to taking an unsecured business loan. However, if you consider a loan after careful assessment, it can give your business an edge and significantly improve your chances of long-term success. 7 Businesses that sailed through the pandemic.

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