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What is a business loan?

The term business loan denotes capital availed by businesses for the purpose of business. Funds availed as business loans attract interest and fees along with repayment of the principal. Specifically intended for business purposes, in the present context, business loans require regular repayment on pre-agreed schedules. However, the repayment terms and conditions inclusive of the rates of interest and other charges vary depending on the lending institution.

In short, a lending institution and a borrower come to create a debt, which must be repaid along with interest. Business loans differ in many ways, and as such are expressed in terms of types of business loans that include bank loans, mezzanine financing, asset-based financing, invoice financing, microloans, cash advances, and cash flow loans.

How do business loans works?

Business loans work the same way other loans work with the exception that funds availed by way of a business loan can be used for purposes related to business. Just like any other loan, you select the type of loan you require, decide the amount of money you need to borrow, select the best interest rate option you can afford to pay, determine when you want to repay the loan and in how many instalments, check your eligibility and documentation needs, and apply for a loan. Such a loan can be used for working capital needs, construction, inventory, and varied other business purposes.

Types of Business Loan

Here are some most common types of business loans available.

  • Term Loan
  • Start-up Loan
  • Working Capital Loan
  • Loan against Property for SME
  • Invoice Financing
  • Equipment Financing
  • Business Loan for Women
  • Overdraft
  • Merchant Cash Advance
  • Business Credit Card

Importance of a Business Loan

In a changing economic scenario, business loans are funds that make the difference between success and failure. Threatened by restricted fund flows, and increasing needs, a business looks for sources of funds for relief from walking on the edge. Such loans are a boon that help in times of working capital needs, business expansion requirements, and other such circumstances. These loans act as a stabilizing factor that strengthens a commercial venture.

A business as an entity comes into formation with objectives to grow, expand, flourish, and sustain. Funds are an essential need at every step in this process of evolution. The process of growth and expansion begins with ploughing back profits into a business, and extends into injecting capital externally by way of funds procured from investors. Looking for funds from external investors' calls for willingness to part with ownership of the business, and this turns out to be a serious drawback.

The option to such a drawback then puts into focus the method of infusion of funds via debt financing without parting with ownership, or losing control of the business. This feasible option allows the management to accrue debt without fear of unwarranted exchange of ownership. Start-ups, small and medium enterprises, and business communities throughout the world look forward to this source of funds without much worry.

  • Business Loan - Economic Cycles Stabilizer

    Economic cycles characterize businesses as entities that are directly affected by factors such as seasons, political instability, international conflicts, etc. These intermittent periods cause economic growth fluctuations, which include declines as well. Small businesses as well as large businesses go through these phases with the help of contingency planning and funding.

    Although, these declines affect small businesses more than the large ones, availability of working capital via business loans sees these businesses through this rough patch. A long-term strategy takes into account slow periods and creates reserves with the help of savings and smart investments for immunity from such economic cycles. Debt acts as a bolster that keeps the business functioning in times of emergencies. Small businesses need to maintain fiscal flexibility to survive in times of economic downturns, or fail to sustain unlike big businesses. Small business loans provide the much-needed stability in these periods of waiting for markets to recover.

  • Business Loans - Start-Up Capital

    New businesses need capital to start functioning. From the drawing board to the board room involves going through phases of birth, nurturing growth, and sustaining commercial activity in periods of economic stability as well as in fluctuating periods that result in negative or no growth, of closure of business.

    Starting out as an idea, business needs capital, and infusing such capital comes through business activities of funding start-ups by lending institutions, which act as the source. Debt at such times not only brings the start-up idea out onto the floor, but also seeks partnership throughout the lifecycle of a start-up, in spheres of finance.

  • Capitalize on Profitable Opportunities

    A good economic plan may sound like expanding business steadily while minimizing debt. This will not necessarily mean a foolproof plan for all business owners, since this leaves a business with objectives that restrict growth in times where profitable opportunities are many.

    Liquidity reserves the right to dictate such situations, and potentially profitable times. Flexible plans allow for contingencies as well as for profitable ventures within the scope of a business. Debt financing at such times makes way for funds that can be used to take advantage of potentially profitable situations. Potential gains justify the costs of access to funds.

  • Prudent Debt means Healthy Economy

    Business opportunities attract capital, businesses fund commercial activities, and employment generation depends largely on businesses for sustenance and growth of healthy economies. Lending institutions pave the path to such health with reliability and prudence for a prosperous business outlook.

    Responding to fluctuations and volatility comes easy to the professional, and a business partners by reputed lenders takes into account near to all activities of business that has scope for financing. Business loans are vehicles for those who seek access to funds, and funds infusion into a business calls for profits. Profits are a means to an end, and a healthy buoyant market seeks the well-being of an economy.

Easy availability of business loans causes more businesses to enter the market and explore newer markets. Such funds activate businesses for commercial activity resulting in creation of jobs, which in turn increases spending. Capital availability not only encourages the business community to thrive, but enables economies to flourish.

Questions to consider before choosing a Business Loan

Whether you're a self-employed professional, or a person consulting another to start-off on a new venture, considering a business loan requires careful consideration. Whether you're just starting off, or you're in the process of growing, and establishing your business, debts are the reason for lack of sleep, and growth and success require a steady and stable mind and environment. Before you take that big leap, or step into your borrowing shoes, consider the questions below, and make an appointment with your accountant.

  • Do you really need a Business Loan?

    Ask yourself and your associates if you really require to avail a business loan. You don't want to end up availing funds you don't really need to. Additional debt burden could only hamper your smooth functioning business. Explore other avenues such as angel investors, friends, family, etc., before walking into the moneylender's office. Try thinking of alternatives like credit cards to help finance your business.

  • For what are funds required?

    Determine the reason for availing a business loan. There numerous reason why funds can be availed; determine the reason. Here are a few instances why funds may be required.

    • Start your Own New Business
    • Purchase New Machinery and Equipment
    • Hire New Staff
    • Marketing and Promotion Expenses
    • Improve Cash Flows
    • Expanding Business
    • Stocking New Inventory

    Once you know the exact reason why you need a business loan, you could look for alternatives that suit your needs. May be a microloan could be a better idea than a normal course business loan to suit your needs? Determining the reason why will help you best fit your business.

  • What's the amount you need to borrow?

    Know the exact amount how much you need to borrow. How do you arrive at the amount? Once you've determined the reason why you need the funds, analyse how would be sufficient as a business loan to satisfy the purpose of borrowing. Write your business plan for purpose utilization of those funds. Write out the account heads you'd be allocating the money towards.

    A good business plan will keep you in touch with reality, and help you manage your money much better; no matter when you're running a small business or a large enterprise. Furthermore, detailing your plan with you repayment plan helps you lender understand your needs better.

  • What's your Credit Score, and what does your Credit Report look like?

    Your credit score plays an import role in your lender's decision to approve your loan. Typically, your lender will look at both, your personal credit score and history, and that of your business. Take a good look at your credit report.

    A three-digit number that represents your credit score derives from the records and transaction in your credit report. This score and reflects your creditworthiness, and shines light on your credit behaviour, and credit repayment capacities. Get hold of your credit report from a reputed credit bureau, and review what's within. A good credit score calls for high value loans at good interest rates and better tenures, and becomes a reason for quick approval.

  • What's your current debt burden?

    Calculate your current debt burden before planning another loan. You could land up into a debt trap should you lose track of how much you owe. Categorize your debt between secured and unsecure outstanding loans, and compile a list with a repayment schedule with dates and amounts.

    Too much debt will ultimately land you in a situation where your business loan will not be approved, and this will only add an additional hard credit enquiry entry into your credit report to lower your credit score. Your understanding of your current debt burden will help you work better on securing a new business loan.

  • What would be the Cost of a Business Loan?

    Unearth the mysteries of a red herring by ready the fine print in your business loan offers. There may be small hidden charges and fees that could increase the cost of your loan.

    Consider the following.

    • Interest Rate
    • Processing Fees
    • Prepayment Charges
    • Penalties, etc.

    By not being careful, you could end-up paying more than you ought to. Don't unnecessarily burden yourself with a business loan your cannot afford. Seek advice to satisfy yourself that you're making the right decision.

  • How do you apply for a Business Loan?

    Applying for a business loan and getting the same approved could be a long and tedious process, but if your well-organized and ready, your loan could be approved far more quickly than you think. Consider the following.

    • Research your business loan options
    • Review your Credit Details
    • Research your Lender
    • Put together the Prescribed Documentation
    • Duly Fill Out your Loan Application

    Once done, sit back and relax known you've done your homework well.

Specific Need for Which You Require A Business Loan

In the course of running a business, there are a number of reasons why you may need a loan, a few are as below.

  • Scale Up

    Ploughing back profits as reinvestment for growth takes a long time, and hence business loans are a handy alternative to funds for scaling up operations.

  • Large order

    In the business or manufacturing, large orders mean ramping production from raw material to hiring workers. Sudden demand from extra cash can be met by availing business loans.

  • Cash Flow

    Temporary money shortfalls can be met and sufficed with business loans to de-stress your cash flows and meet business needs.

  • Tax

    Taxation becomes another specific need for the reason why you can take a business loan.

  • Building Credit Score

    Small loan build credit profiles, and with a new business history, taking small loans regularly helps build your credit profile in preparation for larger value loans in the future.

How to apply for a Business Loan?

Availing a business loan can be and intimidating process. Even if you have narrowed down a lender, you might be confused about where to go from there, especially if you're applying for the first time. Apply for a business loan in six steps.

  • Decide why you need a Business Loan
  • Calculate you Debt Affordability
  • Determine your Eligibility
  • Research different Business Loans and Lenders
  • Get your Loan Documentation in Systematised
  • Apply for and await Disbursal of your Business Loan

What is the eligibility and criteria for Business Loans

Personal Loans offered by banks, NBFCs, and lending institutions cater to a variety of financial needs. The lending criteria vary from institution to institution. Here are the different types of Personal Loans offered in the market.

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    Self Employed Professionals (SEP)

    • Doctors
    • Chartered Accountants
    • Company Secretaries
    • Architects
    • Engineers, etc.
  • icon-list

    Self Employed Non-Professionals (SENP)

    • Trader
    • Commission Agent
    • Contractor, etc.
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    Companies are categorized as follows

    • Partnerships Firms / Propretorship Firms
    • Limited Liability Partnerships
    • Private Limited Companies

The following are criteria to avail Business Loans

  • Minimum Turnover: Rs. 60,00,000
  • 3 years' minimum experience in current business, and 5 years of total experience
  • Profitable Business for the last 2 years
  • Age: Minimum of 25 years and a maximum of 65 years
  • Income Tax Returns: Last 2 years
  • Strong Credit History