Startup funding: Applying for a bank loan? Here is what you need to know

Startup fundingStartups in India for long have been the favorites of private equity and venture capital investors doling out funds. Banks, however, have been tough players on the funding scene. While banks in India (both private and public) are beginning to introduce initiatives to cater to startups, the efforts remain largely limited to regulatory guidance and corporate banking incentives. Some of them have stretched out as an incubator for startups but extending loans has been missing from most banks’ strategy to attract entrepreneurs. 

Industry experts say that banks look forward to debt repayment capability from the underlying business of the company, when considering extending debt to any borrower. In other words, there needs to be positive cash flow from operations to have sustainable debt servicing capability. Till then, it would be seen either as bridge funding or kind of equity funding (essentially). Debt being cheaper than equity, they say, holds true only for businesses with positive cash flows and debt itself can become a cause for the business to go down even faster. 

A section of industry observers opine that banks have always found it tough to lend to startups. Globally, banks have withdrawn from startup loans after a string of experiments due to high risk involved. Meena Ganesh, partner at Growthstory and CEO of Portea Medical, says that banks just cannot take the principal capital risk that startups have, given the fact that they make their profits from the spread of the borrowing and lending they do. “So, unless we change the norms of lending , account for the risk, perhaps have different terms of startup lending such as taking some warrants or equity to compensate for the additional risk , it becomes difficult to do startup lending,” she says.

According to Meena, startups that have broken even and are making cash profits, would be more amenable for bank loans, and so would banks that need funds not for product or concept development but purely for working capital or growth. Banks look for comfort on safety of principal and reasonable ability to service the interest from the cash flows. So essentially, until a company starts making profits, bank loans may be difficult to get. Unfortunately, common perception is that most of funds granted to startups are used for marketing, paying salaries and building technology. 

Nagaraja Praksam, an angel investor and member of the Indian Angel Network, says that most funded startups go through due diligence and that widely eliminates the risk for banks. Hence, being funded by venture capitalists could be one of the criteria for banks to extend loans to startups.

“One of the major needs for startups is working capital. Banks should come forward in helping startups as mostly, these are short term needs. Also, when the VC investment money comes into a bank, they could come forward in managing that and extending working capital based on that,” says Prakasam. 

Ash Lilani, co-founder and managing partner of Saama Capital, says that difficult bank loans for startups is a global problem and not just restricted to India. “The primary issue with banks are cash flow and collateral lenders and usually, startups have neither. Banks typically get excited once a startup reaches profitability and has built a collateral base through receivables and inventory,” adds Lilani.

There is a silver lining in the cloud for capital-constrained startups, though. 

Emergence of niche lenders such as the Silicon Valley Bank has helped create global venture ecosystem. Innoven Capital in India, for example, was the first player to establish venture debt in India. It focuses on startups and has built expertise in understanding the different cycles of capital raising and growth such companies experience, which has helped them create specific products that work for young companies.

Ajeet Khurana, an active angel investor who has invested in firms such as Koonk Technologies, Rolocule Games and Karmic Lifesciences, says that banks could take a leaf out of the venture debt industry and can definitely come up with a debt product for startups. “Three specific features that can go into a startup specific debt product are a moderate rate of interest of 12-14 percent, lending to funded startups and working closely with investors to encourage repayment compliance. Startups can provide limited equity warrants– in addition to the interest–to provide banks with a small additional incentive to loan them money,” he says.

Learn more about finance and accounting outsourcing and banking relationships at Aristotle Consultancy.

Source – Kotak Business Boosters

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