Guest Articles

Thursday
September 12
2024

Bhavik Vasa

Solving the Funding Challenges of Indian MSMEs: The Advantages of Founder-Friendly Non-Dilutive Financing

Like in other countries, India’s micro, small and medium enterprises (MSMEs) play a crucial role in creating employment opportunities. Currently, about 30% of India’s GDP is generated by this sector, which provides jobs for more than 110 million people and accounts for approximately 50% of the country’s exports.

But in light of the 41% dip in private equity and venture capital investments India experienced in 2023, many of these entrepreneurs have begun to shift towards other types of investments. While equity and venture financing continue to persist, Indian MSMEs are gradually moving towards alternative, more founder-friendly types of non-dilutive capital solutions. Just like other debt investments, these financing approaches offer a structured loan without forcing companies to dilute their assets at an early stage. But they also offer some key advantages over traditional loans that make them uniquely suited to the needs of India’s MSMEs.

Below, I’ll discuss the funding challenges facing Indian MSMEs, and how these different forms of non-dilutive financing can address them.

 

Understanding MSMEs’ Funding Challenges in India

Given their huge impact on the Indian economy, it is essential to address the challenges that frequently hinder MSMEs when they seek traditional funding. These challenges include:

The Funding Gap: In India, 63.3 million MSMEs have a total credit demand of Rs. 69.3 trillion. Unfortunately, only 15% of the demand is being met by formal lending methods, according to a 2022 report. To access this traditional financing, companies need to go through elaborate paperwork and accept massive collateral obligations, reducing its accessibility to MSMEs.  

The Limitations of Traditional Bank Loans: Banks consider MSMEs as high-risk investments. Thus, even the slightest macroeconomic changes — from economic slowdowns to interest rate hikes — prompt banks to enforce rigorous creditworthiness measures for these companies. For instance, banks thoroughly scrutinise the financial statements — including balance sheets, income statements and cash flow statements — of these companies to assess their financial health and profitability. Many lenders also deploy specialised teams to analyse MSMEs’ business plans, to assess their potential growth in successive quarters. These measures can result in less capital, and less favourable loan terms, for these businesses. 

Geographic Constraints: In certain remote locations, financing via banks cannot be processed, due to obstacles ranging from connectivity issues to a lack of customer awareness. Thus, it is challenging for businesses in these areas — especially MSMEs — to tap into funding that could enable growth opportunities. Most of the time, they aren’t even aware of the alternative options available to them.

A Lack of Formal Financial Data: Financial statements and past loan repayment records are the two elements most commonly used by venture capitalists and banks to assess lending risk. Many MSMEs — particularly those that are relatively new — lack this information, as they mostly depend on informal funding approaches like personal loans, bootstrapping and even crowdfunding to meet their funding needs during their initial stages. 

Equity Dilution: Some enterprises may seek to sidestep the above obstacles by pursuing equity financing rather than traditional loans. But equity financing can become a pivotal challenge for MSMEs — even bigger than the lack of funding itself — as it forces founders to cede some control of their business to investors, and even causes dilution of profits. 

 

The Benefits of Alternative Forms of Non-Dilutive Financing

To address these challenges, MSMEs can seek alternative forms of non-dilutive capital — an approach that can facilitate sustained periods of profitability without the downsides of equity or traditional debt. These types of financing can ensure funds for businesses without requiring the founders to give up ownership rights or deal with the burdens and limitations of traditional loans. 

Though this financing may come in several different forms, they all take the following general approach:

  • Step 1: The lender assesses the business’ financials by comparing outgoing and incoming cash.
  • Step 2: The lender offers the business a loan amount entirely based on its ability to generate future cash flow. No collateral is involved. 
  • Step 3: Repayments take place throughout the payment term, either as a fixed amount or as a percentage of monthly revenue. 

For MSME founders, several benefits of this approach make it more appealing than more traditional types of non-dilutive financing, including:

  • Faster Loan Approvals and Increased Flexibility: The loan gets approved quickly, with a flat fee, flexible repayment options and very few end-usage restrictions — unlike traditional loans, which may be restricted to covering working capital or other specific business needs.
  • Transparent Terms and Simplified Repayment Structures: Every detail of the loan is explained upfront, and no hidden fees are involved, making it easier for MSMEs to assess their affordability. 
  • Improved Cash Flow Management and Ability to Scale: Along with providing funding to companies, the experienced financing firms that offer these loans also provide practical expertise, and may help with suggestions to expand the venture.

 

Types of Alternative Non-Dilutive Financing

There are several popular alternative types of non-dilutive financing, which include:

Cash Flow-Based Financing: These are structured loan agreements offered to businesses that qualify based on a minimum monthly revenue criteria set by the lender. The repayments are quite flexible, and businesses do not need to pledge any collateral to get the funds. The repayments are taken from the business’ future revenue, making the entire process quite seamless and easy for the founder. 

Marketplace Seller Financing: With these tailored loans, businesses can maximise their online selling capabilities. MSMEs can opt for flexible repayment terms, often tied to their sales volumes. To utilise this financing option, a company simply needs to provide the particulars of its sales history and projections, allowing it to avoid cumbersome paperwork.

Supply Chain Financing: Supply chain financing is a type of short-term working capital finance that is typically used when manufacturers and sellers have already established commercial relationships with each other, and they’re looking to strengthen these relationships with easy access to capital. In supply chain financing, a supplier provides goods to a business, and then receives early payment for these goods from a finance company, which the business later repays with a fee. Funds made accessible through supply chain financing can be repaid through customised repayment schedules, and these loans have simple structures with zero hidden fees. 

Invoice Discounting: Invoice discounting is effective for businesses that experience a gap between the time they provide their products/services and the time they collect payment. In some industries, this gap can last months. To maintain a stable cash flow during this payment term, these businesses approach a financing company that agrees to provide a short-term loan to cover a percentage of their unsettled invoices, after verifying the invoices’ validity — in exchange for a fee. This enables a business to use its own unpaid invoices as collateral for loans, as it pursues repayment from its customers. 

Purchase Order Financing: This type of financing is a great strategy for inventory control. A company first confirms that it has gotten a specific number of order requests from its customers, then provides proof of these guaranteed sales to the financing firm. After checking the authenticity of these invoices, the financing institute disburses payment to the MSME’s suppliers on behalf of the MSME, and the suppliers provide the materials required to produce and deliver these goods. In exchange, the financing institute expects repayment plus a fee, after the business receives payments from its clientele for these products. 

 

How India’s MSMEs are Meeting Their Funding Demands With Innovative Non-dilutive Financing 

The India Digital SME Credit Report, a collaborative analysis GetVantage co-created with the consulting firm Redseer, highlights the growth potential of alternative forms of non-dilutive financing — many of which are offered by digital lenders and targeted towards digitised MSMEs. Though alternative non-dilutive finance accounted for just around 5% of the roughly US $53 billion in funding that went to these digitised companies during FY22, the report found that this number is likely to grow exponentially over the next five years, due to the advantages this type of funding offers to small businesses. On a global scale, the use of alternative types of non-dilutive financing has also grown in recent years. According to a report from the Cambridge Centre for Alternative Finance, the online alternative finance market (excluding China) grew from $89 billion in 2018 to $113 billion in 2020, with substantial increases in the volume of this lending that went to MSMEs. 

At GetVantage, a leading embedded finance fintech in India, we’ve built a cash flow-based financing platform that aims to democratise access to capital by making fast, fair, flexible, non-dilutive funding available to the country’s millions of MSMEs. The platform facilitates data-driven investments for business owners from direct-to-customer, business-to-business, Software as a Service, e-commerce and other sectors. With our tech and data-driven proprietary API stack, GetVantage is reimagining venture finance by expanding access to founder-friendly, non-dilutive growth capital. We believe that providing MSME-focused forms of non-dilutive financing unlocks new possibilities for these businesses, while also helping them streamline their cash flows. But most importantly, this funding allows them to run their ventures without worrying about equity dilution, or onerous loan requirements or repayment terms.

Due to these advantages, many MSMEs have already leveraged these innovative forms of non-dilutive financing to rapidly scale and compete with more established companies within the same sector. We look forward to bringing these promising approaches to other founders who are looking to accelerate their ventures’ growth journey.

 

Bhavik Vasa is the Founder and CEO of GetVantage.

Photo courtesy of Thirdman.

 


 

 

Categories
Finance, Investing, Technology
Tags
business development, credit scoring, digital finance, fintech, lending, MSMEs