Pros and cons of business loans: A quick guide

Introduction 

Thinking big for your business? Need capital to make it happen? Business loans might be your ideal solution, but they don’t come risk-free. If your company is doing well financially and you have a decent credit score, you’re in an excellent situation. However, despite the increased availability of loans for businesses of all sizes, getting authorised can still be difficult. 

According to recent statistics, while quarterly disbursements for MSMEs have increased threefold in the last two years, approval rates for medium-risk MSMEs have remained stable, highlighting lenders’ restrictive risk appetite. 

In this article, we discuss the pros and cons of business loans, guiding you through both the ups and downs of investing in your business goals.

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What is a business loan?

A business loan is an important type of commercial lending available for authorised businesses. These funds offer flexibility, allowing businesses to address a variety of demands such as operational costs, buying machinery, customer payments, and overall business expansion. 

These loans provide a lifeline for enterprises in need of financial assistance, especially in their infancy and growth phases. 

Commercial loans are critical in moving organisations forward, whether they are used to sustain everyday operations or to fund future development. Examples of business loans include the below to help you with borrowing money for business guide.

Working Capital Loan

• Used to meet daily business demands, improve cash flow, and grow.
• Ideally suited for startups, MSMEs, and entrepreneurs.
• Short-term loan (up to Rs. 40 lakh) with up to a 12-month repayment period.
• Interest rates are higher than those on long-term or typical business loans.

Term Loan

• Repaid in instalments over a set period  (short, intermediate, or long-term).
• Business loans up to Rs. 2 crore are provided with no collateral required.
• Repayment periods range from 12 months to 5 years.

Equipment Loan

• For large corporations, particularly those in the manufacturing sector, use it the most.
• Does offer tax breaks to businesses. 

Government Scheme Loans

• The Government of India has launched several schemes for people, MSMEs, women entrepreneurs, and other organisations.
• They are issued by financial institutions like banks, NBFCs, RRBs, MFIs, and SFBs.
• Examples include Mudra Scheme, PMEGP, CGTMSE, Standup India, Startup India, PSB Loans in 59 Minutes, and PMRY.

Pros and Cons of Business Loans

Let’s look at the small business loan advantages and disadvantages at a glance.

Pros of Business Loans 

When it comes to borrowing money for your business, bank loans emerge as powerful allies, offering a host of advantages for businesses out there.

1. No collateral, no worries

One key benefit of business loans is the lack of collateral requirements. This means you can raise financing for your firm without the loan risks for entrepreneurs. There is no requirement for warranties or trustees,  thus keeping your property intact. In the event of an unforeseen issue, the lender will not look at the company’s or your personal possessions, giving you peace of mind. 

Also read: Financial Planning for Entrepreneurs

2. Attractive interest rates

When it comes to business loans options from traditional banks, size matters – in a good way. Larger loan amounts with appealing interest rates become accessible, especially if your credit score is robust. A history of responsible debt management can further boost your standing. Opting for a bank loan often translates to lower borrowing costs, making it a financially sound choice compared to its other alternatives.

3. Flexible use of funds

Banks provide a variety of business loan choices, including lines of credit, term loans, and more. Unlike loans designed for specific reasons, such as business auto loans, typical bank loans are more flexible. This flexibility enables you to invest funding where your company requires it most, promoting growth and expansion. This versatility is a significant benefit when comparing debt financing to equity financing (exchanging a portion of a company’s ownership for money). 

4. Longer terms 

Business loans often have compensation durations ranging from five to seven years. This prolonged term provides more manageable monthly instalments, reducing the impact on your business’s finances. While it may mean paying more in interest throughout the loan’s life, the benefit of a smaller monthly payment allows your firm to flourish. 

Cons of Business Loans

While borrowing money for business has many benefits, it can also have some negatives. 

1. Extensive application process

Applying for an organisation’s funding can be time-consuming. Lenders will assess your company’s repayment ability, demanding a thorough paperwork procedure. Beyond simply filling out an application, you may be required to provide two or three years of tax returns, financial records, and a detailed business plan to convince your lenders.

2. Strict Eligibility

The high qualifying standards present a considerable barrier to obtaining a bank loan. Not all businesses meet the approval standards, like those with poor credit or negative cash flow encountering potential challenges. Furthermore, banks mostly prioritise larger organisations, making it more difficult for smaller businesses to obtain the capital they want.

3. Paperwork requirements 

Obtaining a commercial loan often requires dealing with a documentation nightmare. Banks usually require copies of your private and professional information, as well as financial paperwork and licence details. Prepare to gather information about your present debts, invoices, and accounts dues and payables.

4. Longer waiting period and processing time 

Applying for a bank business loan can be a test of patience. Whether you apply online or in person, the wait time for a loan approval can be several days or even weeks. Choosing online or alternative lenders, on the other hand, typically results in a faster response, generally within 24 hours.

Furthermore, when it comes to funding periods, banks typically move at a slower pace than their online counterparts. Even after formal approval, it could be several days before the loan proceeds are released.

Also read: Beyond interest rates: The hidden costs of personal loans revealed