SME FINANCING

ABOUT MSME
o

MSME refers to Micro Small & Medium Enterprises. It is a generic

term used for small scale Industrial (SSI) units.
The MSMED Act of 2006 classifies enterprises based on the
amount of investment in Plant/Machinery/Equipment.
Classification

Investment in Plant &

Machinery for
Industrial Units (INR)

Investment in Equipment
for Service Sector
enterprises (INR)

Micro

Upto 25 Lacs

Upto 10 Lacs

Small

Above 25 Lacs and upto Above 10 Lacs and upto 2

5 Crores
Crores

Medium

Above 5 Crores and

upto 10 Crores

Above 2 Crores and upto 5

Crores

Presence & Impact of Micro, Small & Medium

Enterprises
o

SME is considered the backbone of an economy because of its

sheer size and importance.
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Contributes 8% to Indias GDP.

Employs 101.2 mn people in 44.7 mn units. Creates millions of jobs every
year
Total assets employed worth Rs 11.76 lakh crores.
Has a 45% share in the industrial output.
Share of 36% in exports.

Globally, 99.7 % of all enterprises in the world are SMEs.

NATURE OF FUNDING
Debt
Funding

Financial
Grants

Nature
of
Funding

Mezzanine
Funding

Equity
Funding

DEBT FUNDING
Debt options for Term facility.

Government schemes like Collateral free loan up to

INR 1 cr
SIDBI funded SME loans

Debt funding for working capital is available via various

credit lines like bill discounting, traditional bank
overdraft, securitization of receivables, working capital
term loan, factoring finance (against receivables though
not very popular), commercial paper issuance by banks
for sound rating SMEs, etc.

Debt options for working Capital facility

Bill Discounting
Bank Overdraft
Securitization of receivables
Factoring
Working capital term loan
Commercial papers for Sound rated

DEBT FUNDING
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 neutralize 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.
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.

EQUITY

Equity Financing is the process of raising capital through the

sale of shares i.e. ownership interest in an enterprise to raise
funds.

It involves not only the sale of common equity, but also the
sale of other equity or quasi-equity instruments such as
preferred stock, convertible preferred stock and equity units
that include common shares and warrants.

Apart from traditional funding from close associates, there is a

growing trend in terms of institutionalization of this source.

One can source funding via angel investors either HNIs

individually or wealth management businesses, family set-ups
or angel groups like Mumbai angels and IAN (Indian angel
network).

EQUITY
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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 with
slightly higher ticket size.

Business segment

Type of Investor

Start-ups/Early stage

Angels/HNIs/Family set- Up to INR 5 cr.

ups

Early stage growth with

proven market
product/services

VC Funds + PE funds or
in isolation

Hyper growth venture to Private Equity Funds

establish SME business
owners

Funding amount ticket

size

From INR 5 cr.

Onwards to INR 50 cr.

Upward of INR 10 cr.

Plus onwards

EQUITY

A startup that grows into a successful company will have

several rounds of equity financing as it evolves. Since a
startup typically attracts different types of investors at various
stages of its evolution, it may use different equity instruments
for its financing needs.
For example, angel investors and venture capitalists who
are generally the first investors in a startup are inclined to
favor convertible preferred shares rather than common equity
in exchange for funding new companies, since the former
have greater upside potential and some downside protection.
Once the company has grown large enough to consider going
public, it may consider selling common equity to institutional
and retail investors. Later on, if it needs additional capital, the
company may go in for secondary equity financings such as a
rights offering or an offering of equity units that includes
warrants as a sweetener.

MEZZANINE FINANCING

Mezzanine financing is basically debt capital that gives

the lender the rights to convert to an ownership or
equity interest in the company if the loan is not paid
back in time and in full. It is generally subordinated to
debt provided by senior lenders such as banks and
venture capital companies.

It is thus a hybrid of debt and equity financing that is

typically used to finance the expansion of existing
companies.

MEZZANINE FINANCING

Mezzanine financing is usually provided to the borrower

very quickly with little due diligence and little or no
collateral on part of the borrower and is aggressively
priced to generate a return in the 20-30% range for the
lender.

Products: Convertible Debentures, Preference stocks

with convertible options or senior debt with
participating options at later date in equities via
warrants.

GRANTS

International Financial Institutions like world Bank, IMF

and similar institutions tend to offer financial grants to
sun rising ad technologically proven sectors to take
advantage of hyper growth prevailing in these sectors.

For example, enterprises in solar power or bio gas

power enjoys financial grants from various overseas
trade associations.

TYPE OF FACILITIES AVAILABLE

Debt Funding
Term Loan
Working capital Financing (Cash Credit/Overdraft)
Loan Against Receivables (Factoring)
Bill Discounting
Letter of Credit
Packing Credit
Foreign Borrowing (ECB)
CGTMSE
Equity Funding
Venture Capital
Private Equity

PROCESS ADOPTED BY BANKS

o

Banks play a crucial role in the funding of SME units and

accordingly SME is designated as a priority sector for the
banking system.
Banks have traditionally relied on a combination of
documentary sources of information, interviews and visits,
and the personal knowledge and expertise of managers in
assessing and monitoring business loans. However, when
assessing comparatively small and straightforward business
credit applications, banks may largely rely on standardized
credit scoring techniques (quantifying such things as the
characteristics, assets, and cash flows of businesses/owners).
Using such techniques and also centralizing or rationalizing
business-banking operations generally can significantly
reduce processing costs

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Banks Strategies for improving the access to funds for

SMEs
Improved Risk Management Systems
Cluster Based Approach
Bill / Invoice Discounting
Micro Finance
Credit Rating
Credit Guarantee
Setting up of SME Loan Factory
Venture Finance & Private Equity

CLUSTER BASED APPROACH

o

Cluster based approach for financing SMEs offers

possibilities for reduction in transaction costs and
mitigation of risk

Risk profile of each cluster is being studied by

professional credit rating agencies and report is made
available to banks

Nation-wide 388 clusters of SMEs identified to facilitate

banks in focused lending to SMEs.

RECEIVABLE FINANCING
oBills

/ Invoice Discounting / Factoring.

oOffers

an alternate mechanism to meet the working

capital needs for quick and
hassle free dispensation of credit.

oEffectively

oFinding

addresses the problem of delayed payments.

increasing acceptance by both banks and SMEs

while innovative models for discounting are being put
into use.

VENTURE CAPITAL

Venture capital is a source of financing for new businesses.

Venture capital funds pool investors' cash and loan it to
startup firms and small businesses with perceived, long-term
growth potential. This is a very important source of funding
for startups that do not have access to other capital and it
typically entails high risk (and potentially high returns) for the
investor.

The stages in venture capital investing are as under:

1. Seed Stage
2. Early Stage
3. Formative Stage
4. Later Stage

Financing of MSME
Given the importance of MSME in the working of an economy, it is
pertinent that this sector performs well in the long run.

However the SME sector faces many challenges to operate

successfully:
Access to formal finance
Quality industrial infrastructure
Marketing of products
Lack of adequate working capital
Technology upgradation and improvement inquality of products
Delayed payments to SMEs
Sickness and NPA management

Poor financing remains the single biggest problem for

SMEs and inadequate access to funds is the main
reason for its going out of business.
It is also acknowledged that these enterprises are
underserved in terms of finance and has led to the so
called SME Finance gap and has given rise to
considerable debate on the best methods to serve this
sector.

Two alternatives for expanding the reach for SMEs

First Alternative
o The first alternative is to broaden the collateral based approach by encouraging banks
to finance SMEs with insufficient collateral. This might be done through an external
party providing the collateral or guarantees required. Unfortunately, such schemes are
counter to basic free market principles, and they tend to be unsustainable.
o Based on this alternative a scheme of Credit Guarantee fund trust for micro & small
enterprises (CGTMSE) has been put in place. In this scheme collateral free loan up to
Rs 100 Lacs can be obtained from banks. The advances made are guaranteed by the
fund and up to 85% of the losses are covered in the event of default.

SECOND ALTERNATIVE

A substantial portion of the SME sector may not have the security required
for conventional collateral based bank lending, nor high enough returns to
attract formal venture capitalists and other risk investors. In addition,
markets may be characterized by deficient information (limiting the
effectiveness of financial statement-based lending and credit scoring).

Thus, the second approach has been to broaden the viability based
approach. Since the viability based approach is concerned with the
business itself, the aim has been to provide better general business
development assistance to reduce risk and increase returns. This often
entails a detailed review and assistance with the business plan.

CONCLUSION : OUTLOOK FOR SMES

SMEs continue to be the thrust area for Government policies.

The growing economy and the tremendous market potential of the
country augurs well for the sustained growth of SMEs in the
country.
SIDBI as the apex institution will continue to play its key role in
facilitating timely and adequate credit besides meeting the
developmental needs of the sector.
With the enactment of MSME Act, the sector is all set to emerge as
the most significant player in national economy.

THANK YOU