SME Finance: Challenges & Major Trends

SME financing is the probable pain point for emerging enterprises but if optimized and understood it can be a gain point for SMEs as well! Critical questions and financial formats complementing SME realities were discussed and decoded by Jayant Tewari, CEO & Financial Technologist, who was our expert of the week at www.moneycontrol.com SME Chat. Here’s the transcript of the chat.

Why are SMEs not known for transparent accounting?

I hold the CA Community responsible which promotes a Tax avoidance / evasion culture - they see their primary role as being Tax savers rather than Business facilitators - the process in fact is a business debilitator as it eliminates the track record which could lead to better funding opportunities.

Why do so many micro-businesses stay micro? What initiatives should be taken by the govt. to boost and encourage such business models?

Transition is largely strategic in nature and the promoters rarely have the strategic vision to implement it. They also lack the guidance to implement the vision even if they have it. Their local reference group being largely of similar stature can hardly help them.

How to control SGA cost to contribute more effectively towards Bottom-line?

In the context of SMEs, the issue is entirely of analysis and implementation, both are bottlenecks in terms of the professional support available to an SME. The promoter himself is too busy fire-fighting to exercise control.

What are the three major changes that you foresee in SME financing trends?

Increasing pressure on banks to finance under CGTSME Scheme, unfortunately has not yet trickled down to the Branch Level. Online Lending Platforms are being encouraged by large e-commerce players. Increased Angel / VC Funding Activity.

I want to start a business of developing android applications. How much money I should have as my capital? What are the funding options?

Basics of entrepreneurship - apart from what you`ll invest, the business will give you NOTHING for 3 years. Funding options at the ideation level are only available to entrepreneurs who`ve successfully exited at least one venture and have a success track record.

Can we get crowd funding in India? Most banks are not keen to fund even working capital, forget seed funding?

Crowd Funding is beset with Legal issues relating to compliance with the Company`s Act as well as the Income Tax Act. As far as Bank Funding is concerned, there`s nothing available until the Bank has seen a transaction record of at least 6 months. As a promoter you need to be pro-active to build a transactional relationship before you seek bank funding.

What are pre requirements for a technology company to avail benefits available to SME sector?

No "requirements" apart from Registration under the MSME Act - just get registered and take what you can get.

How do I analyse about WPI CPI inflation & IIP?

Don`t waste your time! SME`s are least affected by Macro indicators.

Do you find Modi govt. SME friendly; or it is just a whitewash?

I think any business where the implementation and execution is sound, will prosper in the far more "open" and transparent environment which is being created. That`s not to say that everything will happen and bribery will be eliminated - the difference is that now, after paying the bribe, the work will be done. I hope we all realise that we rarely pay bribes to break rules, we pay to get the work (according to the rules) done faster. And that`s well worth it !!!

In spite of being the growth engine of the country and having enormous opportunities, why are SMEs not an attractive proposition for VC/Private Equity investments?

I think there`s substantial Angel / Seed / VC activity in the SME segment -its just that you have to "prove" your credentials rather than just "claim" them. The onus of proof lies on the business seeking investment.

What are the top three pitfalls that SMEs should worry about?

Over Spending to acquire the Customer. Promising more than the SME can deliver. Running out of Cash.

What are the options to raise finance for technology startup, having turnover of few lacs and need funding to meet its working capital requirements?

Few options from a Debt perspective, apart from loans on the security of your Credit Card - 24% p.a. probably up to a few Lakhs. Beyond that, its equity which you have to seek - starting with the 3F - Family / Friends / Fools in that order, since it’s a high risk game. Only after you`ve grown to a minimum stature, either in terms of revenue or quality of customers, will you be able to access more formal channels.

Is SME finance an alternative strategy to microfinance? What are the pros and cons of SME over microfinance?

SME Finance is still corporate in nature - the Company / business is the borrower. In Microfinance the individual is the borrower. The processes of appraisal and disbursal are entirely different.

Many NBFC are offering funding. What is the difference between taking a small business loan (less than Rs 2 Crore) from NBFC and bank?

The bank will take a minimum of 3 months from Application to Disbursal, but will charge 4 - 6% less interest once approved. An NBFC will probably sanction within a couple of weeks. The personal risk is much higher in the Bank Loan as default has far reaching consequences.

What are the bridge loans options available for small businesses? I am re-financing my existing loans and buying out my partner simultaneously. I want bridge loan for around 3-4 months to the tune of Rs 12 Crore.

Only NBFC`s could help you there - its certainly not easy and depends entirely on the nature of Security. You can provide for the Bridge. On an unsecured basis, you`ll need to approach the informal market at interest rates of the order of 36 - 40% p.a. on a reducing balance basis.

How will Mudra Bank change the fund availability situation in India for SME? SIDBI could not do much about this.

It really depends on how it finally takes shape - if it remains a refinancing agency like SIDBI, it won`t make any difference at all. If it approaches direct SME Lending with a pro-active mindset, it could change the landscape entirely.

Does NABARD and SIDBI offer seed funding for agriculture related businesses. I have a green house dedicated to vegetables. I want to now begin horticulture.

I`m not sure, I think both are in the re-finance space rather than in direct financing - pls approach local (close to the place where you have the greenhouse) Cooperative Banks or Nationalised Banks to evaluate the options available.

How we can raise the funding for a technology company. We are looking for collateral free SSI limit of Rs. 1 Crore. We are in to business of web developement, and software development related to security.

Formal Bank Funding can only be accessed after establishing a transactional track record with the Bank. It`s virtually impossible to get a large sanction as a pre-condition to moving your business to the Bank. If you`re looking for 1 Cr collateral free, you`ll probably get able to get it from a Bank over a 3 year time frame. If your numbers and quality of Customers support it, you should actually look at Angel / Seed Funding agencies.

We are a small trading company, what is best ways to finance our operation?

If you`re into online e-commerce, most of the large e-commerce players (Flipkart/Snapdeal/Amazon) are supporting short term finance for heavy transactors on their portal through 3rd party online lenders - just read an article on this - I don`t have details.

If you`re a brick and mortar trader there`s extremely limited access to funds apart from personal loans or mortgage loans.

The unit is from SME segment, having capital of 2cr & willing to go IPO having expansion program involving capex of Rs.25 cr in garment sector. Please advice us on the expenses to be incurred pre & post IPO? The fund raising amount is Rs.25cr and pl. advice us whether is it beneficial against term loan funding from Banks/FIS ? Also pl. advice us if the unit is just new one, having capital of Rs. 20 lacs only but willing to raise a sum of Rs.2 crores, how to proceed and pre/post cost of IPO?

I don`t think an "IPO" is a great source of funding until you`re in the 100Cr + Revenue segment. The SME IPO is more like a Private Placement / VC Funding exercise than anything else. You should evaluate VC / PE for the first Company and Angel / Seed Funding for the second.

How can we finance multiple units?

Finance is provided to a Company as an entity, not a Unit - so the Company as a whole is the focus and basis of evaluation.

My group companies is an NPA with a group debt of about 70 crore. Is there a way to rehabilate the companies. One of the company was restructured in 2013.

It depends entirely on how the other group Companies are doing - making a reference to BIFR and then working with the Lead Banker to develop a rehabilitation package is the best starting point. Of course, once the Banks start enforcing the Security matters become extremely messy.

How to seamlessly shift from one bank to another? I have borrowed Rs 12 crore from UBI and now want to move to HDFC Bank, as they are offering better rates…

I personally would not recommend the shift itself - my own experience is that it`ll always be easier to expand your borrowing from 12 to 20 Cr in UBI than in HDFC. The shift itself is relatively easy if you have a sanction letter from HDFC - if you only have a verbal assurance, don`t waste your time.

We started our business about 2 years ago and have had a turnover of 8 CR in the last two years. We need a short term unsecured business loan to the tune of about 50 Lakhs. How do we go about this?

I`m surprised your Bankers are not supporting you, unless you`re operationally unprofitable or have taken substantial Bank Finance already. I think you should approach your Bankers and figure out what the issue is. Of course if you`re with an MNC or Large Private Bank, their processes are too rigid for you to get any help.

Can the lack of satisfactory business plans, accounting and other information and inadequate assets for use as security; prove to be a major hindrance for a SME to procure a business loan; or they might be lucky and might get a loan even in these cases?

The lack of a satisfactory business plan can never be overcome. All others can be overcome with the quality and detailing in the business plan as well as the demonstrated track record of the operation. A Business Loan for a Start-Up is a virtual impossibility unless there`s substantial security available.

I have repaid my past loans. Loans availed by my company too were paid on time. But now when I approach the bank for a loan, the bank says that there are credit history issues - bad CIBIL score and hence I have to go for high interest rates.

Please obtain your latest CIBIL Report for your Company and each of its Directors - and sort out the issues listed in the Report. It is also possible that some of your  lenders have not updated CIBIL of the completion of the Transactions and thus the loans continue to reflect in the Report.

My business partner has a bad CIBIL score. He has not paid his education loan six years back. Now when we go for a business loan of Rs 22 Crore, will this bad credit score reduce our chances of getting loans?

Certainly - as he`s a willful defaulter - my suggestion would be to reconstitute the Partnership with his proxy so that he does not figure in the list.

Is it so that many financial institutions give a loan on the basis of future financial projections of the SME? If yes; then there might be great chances of the loan been converted to bad debts; as no one can ever predict the forthcoming micro-macro events in the business and economy as a whole.

That`s the precise reason why lending under the CGTSME Scheme remains marginal inspite of all Banks and the Powers that be pushing it in the Boardroom. I do believe that the thinking will change over the next few years.

Is it true that business lending as a whole is substantially more diverse and complex than personal and residential mortgage lending? Large size and inherently risky nature of many business loans can lead to sudden downfall of the bank/lending institution.

Its Certainly more complex and diverse, but because of substantial risk diversification it`ll never be enough to bring down the Institution - it will bring down the Chief Manager of the Branch, though. That`s why there`s substantial on-the-ground resistance to providing SME Finance.