When it comes to funding a business, there are a multitude of loan options, especially in a country like India. However, businesses often choose the wrong lender or the wrong type of loan, which harms their growth. At Velocity, we believe financial literacy is one of the strongest pillars that enables an entrepreneur to rise above their competition. In our pursuit of making budding business people aware of the various options they have to fund their businesses, we have created this blog post. This blog post discusses everything you need to know about short-term loans and helps you decide if that’s the way to grow your business. Read along!
What Are Short-Term Business Loans?
Before we delve into short-term loans, let us understand what term loans are. Term loans are a way of business financing in which the lender provides loans to the borrower for a specific loan term.
Short-term loans, as the name suggests, are immediate funds provided by banks and other financial institutions to a business for a short period. Short-term loans can be customized per the borrower’s needs, i.e., the loan amount and the EMI amount can be decided by the borrower, but they shouldn’t exceed 12 months. If the term is longer, it’ll be considered a medium or long-term loan. The interest rates for this business loan tend to be higher as the repayment period is short. Short-term loans can either be secured on unsecured (without collateral).
Short-term loans are easier to get than other types of loans; however, they also come at higher rates and can affect your credit history if there are any inconsistencies in repayment.
Types Of Short-Term Business Loans
While there are many short-term business financing options available today, here are the top five predominantly used types of short-term business loans:
Merchant Cash Advance
Merchant Cash Advance (MCA) is a type of short-term business loan where the lender grants the business an advance of capital and purchases a portion of its daily credit and debit card sales. The business can then pay back the advance with a percent of its daily card sales.
Invoice financing (invoice factoring/invoice discounting) is the type of short-term business loan where the funds are sanctioned against invoices submitted by the business. The lender can finance up to 80% of the invoice amount. This type of business loan is extremely beneficial for businesses that face challenges due to the gap between raising the invoice and getting the payment.
Working capital loan
A working capital loan is a type of business loan availed by startups and MSMEs to cover their day-to-day business needs and maintain liquidity when they are short of capital. Working capital loans are best suited for businesses with extremes in their sales cycles and would need funds to meet routine needs during the off-season.
Letter of credit
A Letter of Credit is a document issued by a bank that guarantees the buyer’s payment to the sellers. If the buyer cannot make the payment, the bank covers the full or the remaining amount on behalf of the buyer.
A business overdraft is a set amount added to a business account by the lender that can be used to help a short-term cash flow issue. The business owner may borrow any amount of cash from this account up to a maximum limit fixed by the lender instead of a lump sum. For such loans, the interest is applicable only on the borrowed amount and not the maximum limit.
When To Consider Short-Term Business Loans?
A simple analysis of why you need a loan can help you understand if you should go for a short-term loan. Short-term loans are great if you are in urgent need of cash and do not have the luxury of time. Businesses can leverage them to meet the emergency expenses like building, equipment, or fleet repairs and pay off salaries.
If, on the other hand, you are looking for a large sum with a longer repayment tenure, it is best to avoid short-term loans. Either way, ensure you have a solid credit history for the bank to even consider sanctioning the loan for your business.
Short-Term Business Loans Vs. Long-Term Business Loans
While it might look like the only difference between short-term business loans and long-term business loans is the repayment tenure, that is not the case.
Short-term business loans can be availed of quickly and hassle-free, while long-term business loans can take weeks to get. Short-term business loans are more suited for startups or SMEs than long-term loans, which are known to come in handy for large enterprises. A bad credit score isn’t a problem with short-term business loans, unlike long-term ones. Long-term loans lack the flexibility that short-term loans offer. However, short-term loans are notorious for their higher interest rates due to their shorter tenure.
How To Get Short-Term Business Loans In India?
To avail of short-term business loans in India, the applicant can either visit the lender’s official website or their nearest physical branch. The minimal documentation required for applying for a short-term business loan is pretty straightforward:
- PAN card of an individual or the business
- Duly filled loan application form
- Bank statements for the last six months
- Copy of address proof, such as telephone bill, electricity bill, bank statements, voter ID card, Aadhaar card, passport or driving license
- Copy of identity proof, such as voter ID card, Aadhaar card, driving license, and passport
- Copy of age proof such as Aadhaar card, passport, or driving license
- Certification of Company Incorporation or Establishment Certificate
- Memorandum of Association and Articles of Association of the company
Once you submit the necessary documents and the duly filled loan application form, you can get the loan sanctioned within a few days if you fulfill the lender’s eligibility criteria. After the application process and the loan approval, the EMI for the loan will be directly deducted from your bank account bi-monthly or monthly, depending on your agreement with the lender. That is, frequent payments will have to be made to repay the amount quickly.
Use Revenue-Based Financing For Your Short-term Loan Needs
Short-term loans can be extremely beneficial when you are in a cash crunch. However, they come with their own disadvantages that not every business can afford. If you are looking for a flexible, highly scalable, 100% digital process of raising funds that require no equity dilution, we recommend revenue-based financing (RBF).
Revenue-based financing is a way that firms can raise capital by pledging a percentage of future ongoing revenues in exchange for money invested. Revenue-based financing is relatively cheaper than equity financing options available in the market. RBF investors would not take board seats or place difficult financial covenants on your business. Since the repayment is based on the turnover, in case you are having a bad month, you have the flexibility of repaying a smaller amount. It doesn’t end there! Revenue-based financing has a host of benefits for startups that have a decent turnover and are looking to grow their business.
Being India’s largest revenue-based financier, Velocity provides founder-friendly revenue-based business loans to growing DTC businesses. If you are a D2C brand looking for funding to manage your inventory and marketing needs, apply here, and get funded within 7 days.