4 ways of sourcing funds for SME owners

By Sanjay Gaggar|25th Jan 2013
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Business segment covered by SMEs in India are on growth trajectory coupled with globalisation of Indian Economy. Let’s analyse the potential sources of funding under various category –

Equity funding : In India part from traditional funding avenues from friends and close associates, there is growing trend in terms of institutionalisation of this funding sources. At present one can source funding via Angel investors – either HNIs individually or wealth management business family set-ups or angel groups like Mumbai angels, IAN ( Indian angel network), etc. Lot of city based HNIs are now forming angel groups to fund the local entrepreneurs and SME business set-ups.

There are number of Venture Capital (VC) funds in India as well apart from Private Equity (PE) funds which funds slightly with higher ticket size. Following table best illustrate the business type funding scenario in terms of equity options –

Business segmentType of InvestorFunding amount ticket size
Start-ups/Early stageAngels/HNI’s/Family set-ups Upto INR 5 cr.
Early stage  growth with proven market product/servicesVC Funds + PE funds or in isolationFrom  INR 5 cr. Onwards  to INR 50 cr.
Hyper growth venture to establish SME business ownersPrivate Equity FundsUpward of INR 10 cr. Plus onwards

In addition to this, joint venture and collaborations with foreign partners is another way to raise capital based on capital availability.

Debt Funding – In India, there are number of debt options available based on the stage of business. While there are number of Govt formulated schemes like Collateral free loan upto INR 1 cr. Or SIDBI funded SME loans etc. however conventional norms in terms of lending & business feasibility guided by apex banks Non Performing Asset ( NPA) norms are always on top of the mind with these Institutions.

Typical debt funding for working capital are available via various credit lines like bill discounting, traditional bank overdraft, securitisation of receivables, working capital term loan, factoring finance (against receivables though not very popular), commercial paper issuance by banks for sound rating SMEs, etc.

For export business owners, there are pre-shipment and post-shipment credits available in LIBOR based highly competitive interest rate regime and this should be explored fully to neutralise the foreign exchange exposure against receivables.

Many times overseas suppliers also offers competitive credit facility to Indian buyer to promote the trade and export between both the countries. These facilities are available via buyers credit which in turn is funded by overseas buyers bank.

Off late, Indian SMEs can also avail external commercial borrowing subject to RBI guideline to fund its requirement.

For capital expenditure (capex), apart from Indian banks there are number of NBFCs which offers credit against capex proposals via term loans or operating/financial lease with various derivative products around them.

Mezzanine debt funding – In India, there are some Institutions (Domestic as well Foreign) which offers these kind of funding which is very often a product around mix of equity and debt. Some of the instruments are like convertible debentures, preference stocks with convertible options or senior debt with participating options at later date in equities via warrants etc.

There are quiet a few NBFCs which offers venture debt backed up by PE funding or back to back PE funding round.

Grants – Bilateral trade ties between India & other countries in developed world’s trade/finance association offers financial grants to sun rising and technologically proven/upgrade sectors and to take advantages of hyper growth prevailing in these sectors. For example, many of the solar power or bio-gas power sectors enjoys financial grants from various overseas trade associations.

To summarise below – here is a table

Nature

Debt

Mezzanine

Equity

Grants

Typical StructureRevolving Debt Debt with warrantsEquityAward
Investment HorizonShortLong / MediumLongLong
SecuritySecuredSubordianteNoneNone
RankingSeniorSecondThirdNA
Risk ToleranceLowMediumHighNA
TermDemandTerm/PatientParticipativeNA
CouponFloating/FixedStructuredDividend/Bonus sharesOne time
RatePrimeRisk adjustedValuation & Dilution drivenNA
CustomisationStandardRigidFlexible on business driversSector specific
LiquidityHighMediumLow ( Exit is difficult)NA

To conclude, Indian market for SME funding is growing in terms of players and products around them to suit requirement of business owners and stage of SME business owner to absorb its business & finance structure in terms of cost and funding options.

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