Capital infusion in business can be done through various modes. You can use your own savings to bootstrap your company, but this is not always possible since it restricts you from seizing every exciting opportunity that comes your way.
Another available option is equity financing, where angel investors or venture capitalists inject funds. However, in return, they may ask for a significant stake in the company. The best option is to apply to lending institutions to maintain effective business control and ensure you never miss out on any opportunity.
But wait, there is a catch. Lending institutions offer loans in two different forms: secured and unsecured. Secured financing is backed by business collateral, while unsecured financing is offered based solely on your credit history and income.
Benefits of Secured Business Loan
The following are the advantages of a secured business loan:
- Since the loan is backed by collateral, such as machinery, inventory, or accounts receivable, the lender sanctions funds at a lower interest rate.
- Most secured financing options are available for longer tenures. For example, equipment financing may have a repayment period of 7-10 years, depending on the lender. On the other hand, a commercial loan against property is available with a tenure of up to 30 years.
- You can receive substantial funding on a secured loan. The disbursed amount here depends not only on the creditworthiness of your business but also on the market worth of the collateral. For example, if you apply for a loan against property, the funding can be lower than Rs 15 crore or up to 85% of the property’s value.
- You can utilize the funds obtained through secured financing, especially under a loan against commercial property.
Different Types of Secured Business Loan
The four most popular secured business financing are:
1. Loan Against Property
As the name implies, you can borrow funds for your business by mortgaging your office premises, manufacturing unit, or other commercial real estate. The funds approved under this loan come with flexible usage. From kick-starting a new venture to paying for office stationery, you can use the money for any business purpose.
Furthermore, when you contrast this product with other loans available on the market, you will find that their interest rates are much lower. The rationale for this is the involvement of high-worth real estate, which assures the lender that they have the means to recover their losses in the event of default.
2. Equipment Finance
As the name implies, this loan product assists in purchasing, leasing, or repairing movable capital assets like plant and machinery. This loan product is ideal for those engaged in the manufacturing or production segments.
3. Invoice Discounting
Invoice discounting is secured financing that allows you to leverage your unpaid invoices to obtain funds. Suppose you are a cloth manufacturer and sell products to your retailer on Net 60 payment terms.
However, during this period, you need immediate funding. You pledge your invoice to the lender, and after assessing your creditworthiness and the customer’s track record, the lender may offer funding anywhere between 60-80%.
4. Letter of Credit
Although secured financing, a letter of credit works differently. Let’s understand how. Suppose you, as a cloth manufacturer, want to purchase high-quality yarn from a supplier in a foreign country. Since the supplier is dealing with you for the first time.
They are hesitant to supply on credit. In this case, your bank issues a letter of credit that assures the supplier that if you default, the bank will take responsibility for paying off the dues.
5. Vehicle Financing
Lenders offer funding for the purchase of commercial vehicles. Under such loans, the newly purchased vehicle is hypothecated with the lender until the loan is completely paid off. In the event of default, the lender may seize and resell the vehicle to recover their dues.
Benefits of Unsecured Business Loan
The advantages of unsecured business loan are listed below.
- Since collateral is not involved, and the lender does not have to undergo the complex process of determining the value of the pledged asset, the disbursement time is much faster. In fact, if all the paperwork is in order, disbursement within 24 hours is possible.
- Unsecured financing can be used for any legitimate business purpose. Businesses usually apply for this loan to set up a new office, pay their staff, and acquire raw materials.
- Most unsecured financing has a short repayment period, which translates to savings on interest payable compared to long-term secured financing.
Different Types of Unsecured Business Loan
The following are various forms of unsecured business financing —
1. Term Business Loan
This short-term business financing option is available for a maximum sum of Rs 50 lakh with a repayment tenure of up to 5 years. The loan is approved based on your business’s creditworthiness, revenue stream, and business vintage. The business loan interest rate on such loans with most lenders starts from 17%.
2. Overdraft Facility
Banking institutions usually offer this type of loan. Under this facility, the lender allows its existing customers to withdraw funds exceeding their account balance up to an agreed limit.
This type of loan provides flexibility, as you only pay interest on the sum overdrawn, and for a long time, it remains overdrawn.
For example, your lender has approved an overdraft business loan with a limit of Rs 5,00,000. You used Rs 3,00,000 in April for purchases, even though your account only had Rs 1,00,000.
As your business sales increase in summer, you deposit revenue back into your account. You have covered the overdraft by July, and your account turned surplus. Throughout this period, you have paid interest only on the overdrawn amount (Rs 3,00,000) and only for the months it was overdrawn (April to July).
3. Business Credit Cards
A business credit card operates similarly to a personal credit card but is designed to help manage company expenses. It provides access to a line of credit that can be used for business-related purchases and often comes with features tailored to business needs, such as employee cards, spending controls, and rewards programs.
The maximum funds accessible through the card depend on your creditworthiness and the transactions of your current bank account.
The best aspect of this loan product is that you don’t need to pay any interest if you clear the dues within the payment cycle, which can range between 30 and 51 days.
Conclusion
Secured and unsecured business loan offer distinct advantages to meet various business needs. Secured loans, backed by collateral, typically come with longer repayment terms and lower interest rates, providing substantial funding options.
In contrast, unsecured loans, requiring no collateral, offer quicker disbursement times and are ideal for short-term needs. Choosing between the two depends on your business’s financial situation, funding requirements, and repayment capacity. Assess your options carefully to ensure optimal financial management and growth.
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