Things to know about SME Loan Agreement

The economy of India relies on small and medium enterprises (SMEs) for their contribution to the country’s GDP. This stands at more than 30% of their contribution to the GDP and 40% to the country’s exports.

For many businesspersons, SME loans can be a good source of funding for the purpose of expansion and other capital requirements. For this process, an SME loan agreement plays a vital role in ensuring that the loan is approved and disbursed on time with the necessary information.

If you are considering an SME loan for new business or to grow your existing enterprise, understanding the loan agreement is essential. A well-drafted SME loan agreement protects both parties and ensures clear terms, reducing the risk of disputes later.

Here’s a detailed breakdown of everything you need to know before signing an SME loan agreement.

Also Read: A Guide on Home Loan Balance Transfer

What is an SME loan agreement?

An SME loan agreement is a legal document that outlines the terms and conditions between a lender and a borrower. It covers the loan amount, repayment period, interest rate, penalties, and collateral requirements. This document serves as a safeguard for both parties and legally binds them to their commitments.

Key Components of an SME loan agreement

Before signing an SME loan, it’s essential to understand its core elements. These include:

Loan amount and tenure

• The agreement specifies the loan amount sanctioned and the repayment duration.
• Repayment terms typically range from 1 to 5 years, depending on the nature of the loan and business requirements.

Interest rate and fees

• The document mentions the interest rate (fixed or floating) applied to the loan.
• Processing fees, late payment charges, and other applicable costs are also highlighted.

Repayment terms

• It outlines the repayment schedule, including monthly instalments (EMIs).
• Prepayment or foreclosure clauses and associated penalties may be detailed.

Collateral requirements

• Some SME business loans are secured and require collateral, such as property or inventory.
• In case of default, the lender can claim the pledged assets.

Default and penalties

• The agreement defines the consequences of missing payments or breaching terms.
• Penalties may include higher interest rates or seizure of collateral.

Dispute resolution

It highlights the process of resolving conflicts, often through arbitration or legal action.

Why understanding the terms of an SME loan agreement is crucial

Failing to understand the terms of an SME loan agreement can lead to unforeseen financial burdens. Here’s why you should pay attention:

• Avoid hidden charges – Hidden charges can inflate the cost of the loan.
• Know repayment obligations – Understanding repayment schedules helps avoid penalties.
• Protect assets – Collateral clauses should be reviewed to prevent asset seizure.
• Legal compliance – Compliance with the agreement terms prevents legal action.

Factors to consider before signing an SME loan agreement

Loan purpose clarity

• Clearly define the purpose of the SME loan – working capital, business expansion, or purchasing equipment.
• Different purposes may attract different interest rates and repayment terms.

Reviewing the fine print

Read the agreement carefully to identify hidden charges, prepayment clauses, collateral seizure, and penalties.

Repayment flexibility

• Ensure that the repayment terms align with your cash flow.
• Ensure that the repayment of the loan meets your financial goals for the business as well.
• Look for options to prepay or foreclose without excessive penalties.

Collateral assessment

• If opting for a secured SME business loan, assess the value of the pledged asset.
• In case of default, the lender has the right to liquidate these assets.

Understanding default scenarios

• Defaulting on the loan can severely affect credit scores and invite legal action.
• Check the grace period and penalties associated with missed payments.

Government schemes offering SME loans

Several government-backed schemes provide SME loans for new businesses and existing enterprises.

These include:

Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE)

• Provides collateral-free credit up to INR 2 crore.
• Supports both term loans and working capital loans.

Pradhan Mantri Mudra Yojana (PMMY)

• Offers loans up to INR 10 lakh under three categories – Shishu, Kishor, and Tarun.
• Suitable for micro-enterprises and small businesses.

Stand-Up India Scheme

• Offers credit facilities between INR 10 lakh and INR 1 crore.
• Aimed at promoting entrepreneurship among women and SC/ST communities.

Importance of securing an SME loan agreement

A well-structured SME loan agreement ensures clarity and transparency, preventing future conflicts. Here’s why it matters:

• Defines rights and obligations. This way, both parties know their responsibilities.
• Reduces legal risks and minimizes the likelihood of disputes and legal complications.
• Establishes repayment discipline, encourages timely repayments and avoids penalties.

How to apply for an SME loan

Applying for an SME loan is a simple process, but you must follow certain steps:

• Compare multiple lenders for the best interest rates and terms.
• Prepare documents and keep them handy. Submit financial statements, KYC documents, and business plans.
• Assess your repayment capacity and ensure that your business can handle EMIs comfortably.

Also Read: What Is SME? SME Full Form, SME Meaning and Understanding Its Role in Indian Business

The Bottom Line

An SME loan agreement is a vital document that outlines the financial and legal terms of your loan. Understanding its terms ensures that you safeguard your business interests and protect your assets. Whether you are seeking an SME loan for a new business or expanding your operations, knowing the ins and outs of the agreement is essential.

Apply for a business loan for SME now to take your business to the next level with the right financial support!

Moreover, leave it to an EMI calculator to calculate your monthly EMIs accurately and plan your financial goals for the business accordingly.

FAQs

Q.1. How does an SME loan work?

A. Loans for Small and Medium Enterprises (SMEs) are business loans extended to such enterprises. They are tailor-made to suit the needs and requirements of SMEs. Typically, they don't require any collateral.

Q.2. What is the interest rate on an SME loan?

A. SME loan interest rates in India typically range from 8.85% to 26% p.a., depending on the bank, loan type, and the borrower's creditworthiness.

Q.3. What are the criteria for SME?

A. SMEs usually need at least 3 years of business vintage, a post-issue paid-up capital of up to INR 25 crore, and a proven track record with positive cash accruals and net worth.

Q.4. What is SME finance in banking terms?

A. SME finance is the funding that small and medium-sized enterprises receive.

Q.5. What are the disadvantages of SMEs?

A. Some disadvantages of owning a small business include possible income instability, financial risks, uncertainty in business, and longer working hours for employees compared to established businesses and firms.

Disclaimer:

The contents of this article are for information purposes only and not a financial advisory. The information is subject to update, revision, and amendment and may change materially. The information is not intended for distribution or use by any person in any jurisdiction where such distribution or use would be contrary to law or regulation or would subject Godrej Capital or its Affiliates to any requirements. Godrej Capital or its Affiliates shall not be responsible for any direct/indirect loss or liability incurred by the reader for making any decisions, financial or otherwise based on the contents and information mentioned. For more information, please visit www.godrejcapital.com