The basic necessity for establishing any type of business is the timely availability of funds. The privileged entrepreneur can set up a business very easily as funds are readily available at his/her disposal. The majority of the aspiring entrepreneurs, however almost always rely on investors or various financial institutions for their assistance with funding. In this article, we are talking specifically about the latter and how different types of business loans cater to the different needs of budding entrepreneurs.
There are chiefly two types of loans that one can avail for their business. They are differentiated by “when, on what condition, and to whom” the fund will be disposed of by the bank. Namely, Fund-based business loans and Non-fund-based business loans.
Fund-based loans and their types:-
Fund-based loans are the kind of loans where the borrower (entrepreneur) can claim the sanctioned amount as and when he demands for meeting his requirements. A particular period needs to be specified to the concerned bank for the repayment of the loan. Fund-based loans are of the following types.
- Term Loans: These are short-term loans extended for a period of one to five years. These are extended to enable the borrower to purchase producing assets like Plant, Machinery, or other types of equipment.
- Project Financing: These are long-term loans extended for more than five years. They enable the borrower to create or acquire large-sized assets.
- Balloon Loans: In this kind of loan the borrower is expected to pay only the interest amount charged by the bank and the actual principal amount is paid at the end of the term. It substantially reduces the burden of early diversification of profit on the borrower’s part.
- Working Capital Loans: They are usually extended to help the borrower avail of funds for any stage in his working capital cycle, e.g. during the purchase of Raw materials, during the manufacturing process, during marketing, or during the sale.
Non-fund-based loans and their types:-
Non-fund-based loans are the kind of loans where the borrower (entrepreneur) cannot claim the funds by himself. Here, the bank acts as an insurance provider in case of any act of defaulter. Non-fund-based loans are of two types.
- Letter of Credit: If there is an issue of mistrust between an importer and an exporter for a business deal, the bank intervenes to sanction the deal and take the risk on behalf of the borrower.
- Bank Guarantee: Here, in case of any mishappening on the borrower’s part, the bank pays off all of his/her debts.
Thus, business loans are made available for the sole purpose of the betterment of the ease of doing business. Different types of loans are made available that are suitable for specific kinds of businesses. It is thus important for the budding entrepreneurs to find a loan that tunes in well with their model. Financial education also plays a very central role in this regard.