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What is Business Loan and How does it work?
Navigating the financial landscape of a business often brings entrepreneurs to an important question: how to fund growth and operational needs effectively. In recent news, the rise in demand for Business Loans highlights their critical role in bridging the gap between ambition and achievement. Business Loans are more than just a financial resource—they are a strategic tool that empowers businesses to seize opportunities, fuel expansion, and weather uncertainties.
As trends indicate a rising demand for business loans for women and other niche sectors, it’s clear that understanding the nuances of working capital loans and how to apply for business loans can be the difference between stagnation and success. But what exactly is a Business Loan, and why is it becoming an indispensable part of the business journey? Let’s break it down and discover how this financial lever can drive your business forward.
But wait before we get into the details. Are you a business owner who is looking to expand your business? Then you are at the right place. Velocity offers working capital up to ₹5 Crore specifically for digital-first companies. Plus, there’s no need to give up equity or secure collateral – it’s a simpler way to access the funds you need. With over ₹800 crore disbursed and more than 1,000 brands supported, Velocity has a proven track record of helping businesses like yours achieve growth through accessible financing. Find out more about our solutions here.
What is Business Loan
A Business Loan is a tailored financial product designed specifically for entrepreneurs and businesses to access external funding for various needs.
Unlike equity financing, where ownership stakes are exchanged for capital, a Business Loan allows businesses to retain full ownership while repaying the borrowed amount over time. Whether sourced from a bank, online lender, or credit union, Business Loans offer flexibility—funds can be received as a lump sum or through a line of credit. These loans are vital for maintaining cash flow, financing expansion, and covering operational expenses without diluting the company’s equity. Business Loans cater to a wide range of borrowers, from self-employed individuals and private companies to MSMEs, providing the necessary funds to meet working capital requirements, capital expenditures, and other business-related activities.
When applying for a business loan, it’s crucial to understand the process thoroughly. The application procedure typically involves submitting financial documents and a business plan. Before you apply, ensure you have a clear purpose for the funds and a solid repayment strategy. Many lenders now offer online platforms where you can apply quickly and easily, streamlining the process for busy entrepreneurs.
As you consider applying for a business loan, remember that each application may affect your credit score, so choose your applications wisely. It’s also beneficial to compare different lenders and their terms before submitting your application. This way, you can find the best fit for your business needs and financial situation.
Get an equity and collateral-free term loan from Velocity.
Want to understand more about equity and collateral free term loan? Read our blog What is cash-flow based financing? – A Complete Guide 2024
Types of Business Loans in India
Business loans are crucial for funding various business needs, whether for daily operations or long-term investments. In India, business loans are broadly categorized into the following types:
Working Capital Loan
Working capital loans are designed to help businesses meet their short-term operational needs, such as managing cash flow, purchasing inventory, or covering payroll expenses. These loans are generally short-term, with amounts up to ₹40 lakh and a typical repayment tenure of up to 12 months. The interest rates are usually higher than long-term loans, and the loan amount can only be used for specific business purposes as defined by the lender.
Term Loan
Term loans are repaid in regular installments over a set period. They can be short-term (up to 12 months) or long-term (up to 5 years or more). These loans may be collateral-free, with amounts up to ₹2 crore or higher, depending on business requirements. The repayment terms are agreed upon during the loan application process.
Letter of Credit
A letter of credit is a financial instrument used primarily in international trade. It provides a payment guarantee to suppliers, ensuring that businesses involved in importing or exporting goods have the necessary assurance of payment before completing transactions. This type of credit is essential for businesses dealing with unfamiliar international suppliers.
Bill/Invoice Discounting
Bill or invoice discounting allows businesses to receive immediate payment on outstanding invoices before they are due. In this arrangement, the bank advances the invoice amount at a discounted rate, providing the seller with liquidity while the buyer pays the full invoice amount at a later date. For example, if a seller is owed ₹10 lakh in 45 days, they might receive ₹9.5 lakh immediately from the bank, with the remaining amount paid by the buyer on the due date.
Overdraft Facility
An overdraft facility allows a business to withdraw funds from its bank account even when the account balance is zero. Interest is charged only on the amount used and is calculated daily. The credit limit is determined by the account holder’s relationship with the bank, credit history, and cash flow. The overdraft limit is typically reviewed annually and can be used flexibly, provided the interest is paid on time.
Equipment Finance or Machinery Loan
Equipment finance or machinery loans are used to purchase or upgrade equipment and machinery. These loans are particularly common among large enterprises and those in the manufacturing sector. Borrowers may also benefit from tax deductions. Loan terms, including interest rates and repayment periods, vary by lender.
Loans under Government Schemes
The Indian government offers various loan schemes for individuals, MSMEs, women entrepreneurs, and businesses in the trading, services, and manufacturing sectors. These loans are available through private and public sector banks, NBFCs, Regional Rural Banks (RRBs), Micro Finance Institutions (MFIs), and Small Finance Banks (SFBs). Notable government schemes include the Mudra Scheme under PMMY, PMEGP, CGTMSE, Standup India, Startup India, PSB Loans in 59 minutes, and PMRY.
Point-of-Sale (POS) Loans
POS loans, or Merchant Cash Advances, are short-term loans that allow businesses to borrow against future credit or debit card transactions. This type of loan is commonly used by merchants facing short-term cash flow issues. The interest rates for POS loans are typically higher than other business loans, and repayment is tied to the business’s daily card transactions.
When considering these loan options, businesses should carefully evaluate their specific needs, financial situation, and ability to repay. It’s advisable to compare offers from multiple lenders, including banks, NBFCs, and other financial institutions, to find the most suitable terms and interest rates. Each loan type has its own set of eligibility criteria, documentation requirements, and approval processes, which should be thoroughly understood before applying.
Business Loan Fees and Charges
When applying for a business loan, lenders typically impose various fees and charges on borrowers. These fees can vary significantly depending on the lender. Below is an overview of some common charges associated with business loans:
| Particulars | Charges |
| Processing Fees | Up to 6% of the loan amount |
| Prepayment Charges | Up to 5% of the outstanding principal |
| Penal Interest | 2% to 6% on the outstanding loan amount |
Business Loan Features and Benefits
Business loans come with a range of features and benefits, which can vary across lenders. Some of the key features include:
Secured and Unsecured Loans: Most banks and NBFCs offer both secured and unsecured business loans.
Variable Interest Rates: Interest rates differ based on the applicant’s credit profile, business nature, type of loan, and the nature of the collateral or security provided.
Top-up Loans: Existing business loan borrowers may be eligible for top-up loans over and above their current loan.
Overdraft Facilities: Some lenders offer overdraft facilities to existing business loan borrowers.
Pre-approved Loans: Both new and existing customers may apply for pre-approved business loans, which offer instant disbursal and require minimal documentation.
Concessional Rates for Women Borrowers: Many lenders offer lower interest rates to women borrowers.
Online Application: Applicants can apply for business loans online, with quick approval, minimal documentation, and fast disbursal.
Eligibility for Business Loans
Lenders generally consider the following criteria when assessing eligibility for a business loan:
Age: Applicants should be between 21 years old at the time of application and 65 years old at the time of loan maturity (this may vary by lender).
Business Vintage: The business should have been operational for a minimum of 3 years, though some lenders may require 5 years.
Business Turnover: Minimum turnover requirements range from ₹90,000 to over ₹250 crore.
Credit Score: A credit score of 750 or above is typically required, though some lenders may accept lower scores.
Minimum Income: Applicants should have a minimum income of ₹1 lakh per annum.
Eligible Entities: Business loans are available to MSMEs, proprietors, LLPs, private limited companies, public limited companies, self-employed individuals, and professionals such as doctors, CAs, and architects.
Documents Required for Business Loan
To apply for a business loan, the following documents are usually required:
- ID Proof: Voter ID, Driving License, Aadhar Card, or Passport
- PAN Card: Required for partnership firms, individuals, and companies
- Address Proof: Telephone/electricity bill, Voter ID, Passport, Bank Statement, Driving License, registered lease deed or sale agreement, NREGA Card
- Age Proof: Birth certificate, PAN card, Aadhar card, Passport, etc.
- Ownership Proof: Proof of residence or office ownership
- Business Continuity Proof: Evidence that the business has been operational
- Company’s PAN Card: For business entities
- Business Registration Proof
- Photographs: Passport-sized photographs of the applicant
- GST Returns: Latest returns filed
- Bank Statements: Last 6 months’ bank statements
- Income Tax Returns (ITR): Latest ITR along with income computation, balance sheet, and profit & loss account for the last 2 years, certified by a CA
- Sole Proprietor Declaration or Certificate
- Partnership Deed: For partnership firms
- MOA, AOA, and Board Resolution: Certified copies for companies
These details help ensure that both lenders and borrowers are clear on the requirements and obligations involved in securing a business loan.
As we approach the end of this discussion, we just wanted to remind you that Velocity is revolutionizing access to growth and working capital for underserved Indian businesses. Through cash flow-based financing, we offer innovative, equity-free, collateral-free, and interest-free funds leveraging business data and online cash flows. Having disbursed over ₹800 crores, we have served 1,000+ brands by fueling their growth with accessible capital. Click here to understand more about us.