Startups today are playing a crucial part and contributing handsomely to the growth of the economy. They are the vibrant, diverse and innovative channel through which smart ideas and tech are changing the way we live. Additionally they are creating more jobs, building value in products, adding to the foreign exchange kitty, improving the standard of living and a lot more.
It is evolving so fast that the IT industry body NASSCOM estimates that by 2025, the Indian startup ecosystem is expected to have a cumulative valuation of USD 600-700 billion.
What this statistic clearly points out to, is the incredible potential that the Startup domain possesses. Now, think startup and then think funding; that is how this domain works. Given the numerous unicorn success stories being tracked and reported, it does seem logical that bank loans to startups are perhaps easy to access, plentiful and cheap too. Access to a startup loan by government is also what is proving to be a doorway to quick and adequate funding. Subscribe to CoffeeMug to learn more about how to generate funding for your startup without any hassles and ensure speedy growth.
However a closer look tells a different story. Bank loans to startups are hard to come by, simply because startup business loans are categorized as the riskiest loans that banks may possibly receive as funding proposals. There are a few key reasons mentioned ahead, which could form the grounds of a bank refusing to bankroll a startup.
1. Cash flow inconsistencies
Banks would always look to lend to a startup, which can establish a consistent revenue generation business model and assure regular cash flow through operations. A small business has a lot of expenses to bear to keep its business up and running and at times banks are wary of lending, since they fear that a stuttering cash flow could easily lead to a loan default.
2. Insufficient collateral
Loan applications to banks always include a request for an encumbrance free and valid collateral to process the loan. Startup promoters at times lack this, which leads to the rejection of the loan application.
3. Poor work experience of the promoters
Banks would always check for a track record of the promoter’s work experience, especially in the business vertical the startup is proposing to enter. A weak track record or no industry experience would automatically mean a red flag.
4. Weak core management team
Every bank would be positive of proposals that present proof of a solid, result-oriented management team. It’s reassuring for them to know that their funds will be managed by an experienced team. The opposite however will happen if the bank sees that the team is not strong enough to drive the business and deliver results.
5. Limited customer pool
Banks would always want to fund a startup with a diverse and extensive customer pool. A limited or restricted customer base spells a drop in earnings over a period of time, which makes the startup look an unattractive proposition.
6. Sketchy or insufficient credit history
A strong credit score is a sure shot key to a line of funding opportunities. A startup promoter may not have managed to build and maintain a good score over a period of time, given the uncertainties and financial pressures of a small business. This puts off the lending banks as they feel their money is insecure.
7. Negative debt-to-income ratio
Banks will always be wary of lending to a business that has accumulated unresolved debts with lenders. Startups have to seek a credit line from multiple alternate sources and this can result in a negative marking on their loan proposal.
8. Changed lending regulatory
Banks are subject to advisories and regulations from time to time with regards to lending protocols. This also can be a stumbling block for startups as they may not be able to meet all the statutory requirements and compliances. In such cases banks have no option but to refuse approval for capital.
9. Negative industry or sector marking
At times it may so happen that a startup intends to enter a particular sector that is already saturated or studies reveal a declining growth. In such a case banks will find this a strong reason to reject funding.
However, promoters also need to remember that there are many alternative funding options available nowadays. Another option to explore is startup loan by government where startup promoters can access the various portals initiated by the government wholly dedicated to register startups, as well as, handhold their promoters through the entire process, starting from the application and right through the disbursement of the loans applied for.
Conclusion
Getting to learn the reasons why banks don’t provide loans to startups, can perhaps better prepare you to build an almost rejection proof loan proposal. To learn more about startup funding and the inherent challenges, log on to CoffeeMug.
CoffeeMug brings you know-how on a variety of topics. These can sharpen your perspective on key issues an enterprise faces and guide you to find your own answers. If you need an experienced mentor, well CoffeeMug helps you connect with one too!
FAQs
Q. Why banks don’t lend startups?
A. Because new firms lack their own business credit, the bank must consider the credit of the business owners. Banks frequently reject startup loan applications due to the borrower’s poor personal credit.
Q. What is the most likely reason why creditors will not lend to a company?
A. If your credit score is ‘too low’, it is one of the most prevalent causes for loan refusal. Depending on the lender and situation, the magic score number will vary. Even if your company has been in operation for a long time, your personal credit score is taken into account when applying for a small business loan.
Q. What are the 3 types of financing in a small business?
A. A small business owner has only three options for funding: debt financing, equity financing or a combination of the two. Debt funding is obtained through banks, government lending programs or anyone you can persuade to lend you money, which must be repaid over time with interest.
Q. How do startups raise capital?
A. Most startups use a variety of funding alternatives and stages, beginning with grants, microloans, angel investors and finally venture capital (VC) funding, to seed their businesses and allow them to develop at an exponential rate if their business model allows it.
