Microfinance Vs. Business Loans: A comparison for a better understanding

Every business needs capital to sustain and grow. While the business is still finding ground for the first few years, capital can be hard to come by. Entrepreneurs can approach banks, non-banking financial companies (NBFCs) or certain government-sponsored agencies for a loan. However, the industry you operate in, the size of your business, creditworthiness, loan requirements, and many such factors determine whether you are eligible for a business loan or need to opt for microfinance.

Microloans are intended to benefit entrepreneurs, particularly in the small-scale industry. Given that more than 70% of businesses in India are MSMEs, microfinancing gives people, especially those in smaller towns, an opportunity to become independent and generate gainful employment for others.

Difference between regular business loans and microloans

Understanding the difference between regular business loans and microloans can help make it easier. Here are five key factors to consider.

Lending entity

Microfinance options were previously limited to credit unions, Grameen banks, self-help groups, and non-governmental organisations (NGOs). Intending to drive self-employment, the government has also initiated small-scale MUDRA loans. Various small finance companies, including fintech and crowdfunding platforms, have also been permitted to issue microfinance loans.

Structured business loans, on the other hand, can only be availed through public/private scheduled banks, NBFCs or by specified government agencies such as SIDBI or CGFMSE. The category and value of the business loan determine which type of lender you should approach.

Credit availability 

As the name suggests, microfinance lenders offer smaller loans, usually up to a maximum of Rs 1 lakh. These entities operate intending to help as many small business owners as possible. Hence, the exposure to one single entity is limited to cover a greater breadth of entrepreneurs and limit risk.

Business loans can be of various types, with varying tenure and loan amounts depending on the requirements of your business. These could range from a few lakhs to Rs 1 crore for unsecured funding. In case of higher funding, the bank/NBFC will conduct further scrutiny and may ask you to place collateral.

Loan use

Microloans are issued as startup seeds or to fund business operations, such as purchasing inventory and equipment, paying rent, salaries, etc. These loans cannot be used to offset previous business/personal loans.

Business loans can be of different types. Working capital loans are used for managing business operations and cash flow needs, and equipment/machinery financing is exclusively for purchasing or upgrading assets. In contrast, term loans are for long-term business expansion projects. Business loans are also available through an overdraft facility, letter of credit or bill discounting, which can be explored basis your relationship with the bank. IDFC FIRST Bank offers quick funding of up to Rs 50 lakh based on your current account statement.

Interest rates

Microloans are usually offered for shorter tenures and carry a higher interest rate compared to business loans, usually between 18% to 26%. The primary reason these loans command more interest is due to the inherent credit risk for the lender. The loans are given out to borrowers with little to no credit history and no business track record.

Conventional business loans, on the other hand, are relatively affordable. These loans are usually 1% to 2% over the banks’ Marginal Cost of funds Lending Rate (MCLR) as levied by the RBI. The existing relationship of the borrower with the bank also has some bearing on the interest charged. The lending agency usually conducts adequate due diligence on the borrower, not limited to credit checks, scrutiny of the business balance sheet, and the existing loan mix of the business and promoter.

Loan tenure

Microloans are given out for a short duration only, with the maximum tenure being two years. However, most small loans often have a tenure of up to one year only.

Business loans vary depending on the type of loan. Working capital loans have a short duration of up to 12 months, equipment financing can range from 3 to 7 years, while term loans can be given out for 5 and even 10 years, depending on the expansion plans for the business.

How to ensure your business gets the capital It needs

Documentation and eligibility are key in helping you fast-track your chances of securing business funding. Even though you don’t require a credit standing for microloans, your eligibility has to be established. Whether it is completing Aadhaar based KYC for Grameen loans or receiving MSME status for MUDRA loans.

For structured business loans, you need to maintain a healthy credit score, ensure your books of accounts are in order, and GST filings are regular. If your capital requirements are higher, you may also have to furnish audited profit and loss statements and cashflow statements and declare business assets and liabilities and tax records for the previous years.

Securing the required business capital at the right time is a challenge all small organizations face. IDFC FIRST Bank takes away the uncertainty and stress with its easy-to-secure on-demand business loans. With IDFC FIRST Bank’s business banking, you can get quick loans of up to Rs 50 lakh.

As your business grows and expands, you can get collateral-free funding up to Rs 1 crore for a tenure of your choice for up to 48 months. Whatever your business needs, the IDFC FIRST Bank business loan ensures that your entrepreneurial dreams and aspirations take flight.

Disclaimer

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