Micro, small and medium enterprises or MSMEs are the second-largest generator of employment in India. They are the backbone of the Indian economy and their contribution to service sector GDP is significant. Companies with an investment of up to Rs 50 crore and a maximum turnover of Rs 250 crore can register as an MSME. This entitles them to apply for loans under the MSME Scheme. Most start-ups in India are registered as MSME. Such budding businesses often require small and big loans to help them expand their operations.
Most MSMEs cannot benefit from a traditional business loan. The business loans often involve a lengthy documentation process and pledging collaterals. Even then, many small businesses are unable to get their applications processed. To support these businesses, the government has introduced many schemes such as PMEGP, CGTMSE and ISEC. The loans under these MSME schemes are affordable and easy to get. Let us look at the key differences between a business and an MSME loan.
Type and Scale of Business
Business loans are best for established organisations. These loans can help fulfil their expansion plans. Any business organisation can apply for business loans. On the other hand, MSME loans are available for only those organisations that are registered as an MSME. MSME loans also enable start-ups and small business enterprises fulfil their day-to-day financial requirements. Such enterprises often fail when applying for traditional business loans.
Purpose of the loan
Due to the difference in scale of the borrower, the primary intention behind applying for a business loan differs from that for an MSME loan. The reason behind applying for a business loan is usually growth and expansion strategies or diversification. MSME loans are usually taken to meet the day-to-day needs of the business such as procuring raw material, marketing and purchasing equipment.
Business loans are secured loans, that is, the borrower has to pledge collateral against the loan amount. However, some lenders offer business loans up to Rs 50 lakhs without collateral. MSME loans under the PMEGP are collateral-free. However, the maximum loan amount, in this case, is Rs 25 lakh only.
MSME loans are usually short-term loans. Though the loan repayment tenure for MSME loans is between 1 to 5 years, the loan amount is expected to be paid in s shorter duration. Business loans usually offer a longer repayment tenure. The repayment tenure for business loans largely depends on the loan amount. As the loan amount offered by business loans is greater than MSME loans, the repayment tenure is usually longer for business loans.
The documentation process for availing a business loan is quite rigid. The borrowers have to submit a list of documents without which the loan approval process cannot be completed. On the other hand, MSME loans have minimum documentation and are more flexible with their requirements.
MSME loans have a higher interest rate as compared to business loans. This difference can be ascribed to the difference in the loan amount and the need for security collateral. MSME loans usually have a minimum interest rate of 17 percent. Business loans are offered at a much lower rate starting at nearly 13 per cent.
Security Collateral and Credit History
The organisations applying for MSME loans are usually fairly new. They seldom do not have a credit history to support their loan application. Therefore, MSME loans do not mandate a credit score for processing loan applications. On the other hand, the credit history of an entity plays a pivotal role when applying for a business loan. Most lenders offer business loans to only those organisations that promise and have a good credit score.
The decision to choose between a business loan and an MSME loan can be overwhelming for a budding organisation. The borrower must evaluate all the parameters, including the cost-to-profit ratio. The borrowers must also compare the quotations offered by different lenders. The need to provide security collateral against the loan amount should also play an important part in choosing the type of loan required.