Business is the driving force of an economy, and enterprises of all sizes and capacities contribute to the general upliftment of the economic conditions. The term MSME refers to micro or medium and small enterprises spread mainly at a city or a state level on the basis of their geographic location and capacity. Whether you are a sole proprietor of a store, a restaurant owner, or a textile shop, it comes under a small or medium enterprise category depending upon the organisation’s size.
Some common factors of an SME are private ownership, revenue of less than $50 million, and an employee headcount of less than 250. Medium enterprises play a very important role in the overall production of a country. These businesses have a wide range of requirements such as purchasing plant and machinery, inventory, paying out salaries, etc. In developing economies, SMEs contribute to approximately 50% of the total output of the nation.
Despite the importance of these medium-sized enterprises, they face various hindrances in their financing. To help you understand it further, let us explain the importance of loans for a business. When a microenterprise suffers from a cash crunch and lacks funds to undertake its operating expenses, these loans are extremely useful. Without any dilution of equity, it helps in creating more cash flow. When a business or an enterprise takes a loan as a source of finance, it does not take away the decision-making power from the business owners.
On the other hand, if you have venture capitalists for your business, you will undoubtedly lose equity. Another factor in support of these loans is that the process is quick and not very time-consuming. As the name suggests, these are short-term loans taken for tenure of five to six months.
When looking out for financing sources for your business, you need to be clear on how much money is required and how it will be utilised. Here are a few pointers that show why it is the best option for these MSMEs to opt for loans:
- Quick Process– The process to attain these loans is quicker than approaching venture capitalists as the interest rates are low and with lesser documentation.
- Security– There is no provision of putting your collaterals as a security in case of a default in the loan repayment. This makes it ideal for SMEs to opt for loans as a source of finance.
- Eligibility– With no distinction, any business can procure an easy SME loan or a government-based loan to finance its business without the hassle and easy documentation. The eligibility criteria mainly comprise three factors that money lenders look for while providing loans.
- The duration for which the business has been running so that one can identify the account.
- Credit Score is another crucial factor in ascertaining the decision to advance loans.
- Lenders need to be sure that they have enough money in the business to pay off the debt.
Challenges in Small Business Lending
- The credit information available in the vendor market is fragmented, implying multiple sources of information; therefore, the information is not sufficient to ascertain the future of the loan repayment.
- The default rates in the loans given to these small businesses are way higher than any other loan. Therefore, there is a lack of trust in potential investors towards entrepreneurs.
- The credit rating models for these systems are not efficient enough to duly predict the accountability of businesses due to a lack of information, which in turn makes it even harder for them to procure financial investments.
Furthermore, the SME sector is affected to a much higher degree by the external shocks of the market as it is susceptible. The main risks linked to these enterprises are that they have not been in the market long enough. Hence they are low on experience. The productivity level is also familiar with naturally a high number of defaults in repayments of loans. However, it has been observed that with the right kind of support from the government and these lending houses, SMEs have thrived in times of crisis. The presence of information asymmetry can induce these lenders to make offers that they cannot provide. Due to a lack of regulation and monitoring, firms will initially face these challenges while the process gets smoothened eventually.
With an increasing number of small and medium enterprises, especially in developing nations, there will be a rising need for sources for these businesses to procure short-term investments. These fast small business loans provide speedy resolution to a financial crunch. Based on some of the leading consultancies research, it was suggested that with future opportunities and innovation, the information asymmetry in the vendor market.
With automation, organisations and firms can develop various tools to organise and structure the available information. Development of credit models with information other than just financial statements and credit history so that decisions can be better optimised.
The ongoing Covid-19 crisis has negatively affected almost every industry. It has been a massive challenge for small and medium-sized enterprises to survive the economic meltdown resulting from the pandemic. Most of them have either been shut down due to their inability to cover their operational costs while others are still struggling to survive. With restricted interaction between two parties in person, the pandemic is pushing banks to come up with better ways of communicating with potential clients. The requirement for end-to-end lending has also gone up over the last year. This has created a need for more players to step into the lending market. Therefore, with more currency into the economy, it will not only boost one industry. However, it will also have a positive impact on others.
Overall, the SME loan space has a lot of scope for formalisation and expansionary policy initiatives. We can look forward to large leaps and bounds taking place in this sector soon after the pandemic subsides.