Micro, Small, and Medium Enterprises (MSMEs) are vital to the Indian economy, contributing to employment generation, GDP growth, and overall economic development. Over the past few years, the Govt of India has also encouraged start-ups in various industries and services over the past few years. One critical challenge these new-age entities face is access to affordable and appropriate credit facilities.
Roadblocks faced in raising finance:
- Lack of adequate credit history: New-age MSMEs, such as start-ups and small enterprises, often lack a credit history, which makes it difficult for them to establish creditworthiness. The absence of a track record makes it difficult for the financing institution to assess the risk properly. And the lender usually takes a very conservative call by either reducing the loan amount or demanding stiff terms. Only a small percentage of MSMEs in India have a high enough credit score (e.g., a CIBIL score of 700+). According to a study few years ago, nearly 50 per cent of startups die out before their third anniversary.
- Collateral requirements: Most start-ups and younger MSMEs lack access to acceptable collaterals (viz., property or other assets that can be mortgaged). They are therefore forced to access unsecured loans or funding through private sources. While credit guarantee schemes enjoin lenders to offer loans to MSMEs without collaterals, these schemes have yet to achieve the desired level of success.
- Complex loan application process: Banks and NBFCs often have complex and lengthy loan approval processes, requiring a lot of information. Owing to their inexperience, new-age MSMEs often fail to showcase their businesses and funding needs in the proper fashion. This may result in a higher probability of loan rejection, lower sanction amounts, or delays in approval.
- Tendency to avoid taxes and resort to “informal” sales: There is a tendency for a tax/ compliance phobia among MSMEs. Hence, their books of account may not reflect their true strength, which forces them to remain small. While GST and digital payments have reduced this tendency to deal in ‘cash’, it still remains a huge problem.
- High-interest rates: Understandably, these entities are rated as high-risk borrowers, increasing the interest rate.
- Lack of awareness about government schemes: The Indian government has introduced several schemes to promote credit availability for MSMEs. However, many MSMEs are unaware of these schemes or may not understand the benefits they offer.
What is the way forward?
1. MSMEs should shake off their compliance phobia. Tax avoidance may be tempting but is suicidal in the long term for business growth. Always better to pay taxes and build credible books of account. Even when raising external equity, the promoter’s transparency becomes a critical parameter for the financial institution to assess. No compromise there!
2. Most entrepreneurs are experts in manufacturing and selling but need better financial skills. Learning how to pitch the merits of the business in a fair manner is essential for the borrowers. Understanding business ratios, preparing financial projections robustly, and presenting the case to the lender is critical to raising funds.
3. Start somewhere – and build up over time. Patience is critical to success in business. It is better to accept harsher terms in the initial stages but work towards a more optimal solution over time. In the initial stages, having a higher interest cost but growing faster is more meaningful. A bigger scale automatically leads to lower interest rates.
4. Building up a credit history. The promoter, as well as the business, must ensure that there is no blemish on their track record. Even a tiny lapse in payment of your credit card bill or having a very high utilisation of the credit card limit without paying the total amount on the due date can lead to a lower credit score. Never default on any loan – even if you have a dispute with the credit card issuer/lender, and always pay on time. You can always use the grievance redressal mechanisms (including RBI Ombudsman) available to solve the dispute.
5. Always ensure you use the loan only for the purpose for which it is taken. Lenders draw much comfort from the right end use, making it easier for the MSME to raise further loans. Diverting a working capital loan for buying machinery/office or using an unsecured business loan to deal in the stock market etc., should be strictly avoided.
In conclusion, just as a caterpillar must struggle to become a beautiful butterfly, MSMEs must work to become big businesses. Setting a high moral standard of behaviour is critical to becoming a coveted client of lenders! And there are no viable shortcuts.
Views expressed by K. V. Srinivasan, Executive Director and Chief Executive Officer, Profectus Capital.
