A credit guarantee scheme provides a credit facility to small businesses without collateral. The risk or guarantee of the loan is covered by a third party instead of the enterprise. Thus, some other party or organization will provide the collateral as an assurance to the banks instead of the business taking a loan. This post gives information on the credit guarantee scheme for startups.
Importance Of Credit For Startups
Having access to credit helps a business owner grow their business. Running a business successfully is only possible if you have credit. Liquid money is the lifeline of a business. The following are some benefits of credit for a startup:
- Firstly, funds help you run and operate your business. It enables you to get money for daily expenses and payment of salaries to your employees.
- Secondly, credit helps buy inventory, hire professionals in your company, and do business promotion and marketing.
- Also, funds help in expanding a business. The credit gives you money for investments and enables you to get new business opportunities.
- Moreover, having extra money helps you in increasing your reach among buyers.
- In addition, funds protect you from problems in your business.
- The credit helps you in an emergency if some buyer fails to pay you.
- If you have enough money, you can manage unexpected expenses in your business.
- Also, business owners who have funds can improve their credit scores. A good credit score helps you get loans from lenders quickly and faster at good repayment terms.
- Lastly, having liquidity makes lenders treat you as a trustworthy business.
An Overview Of The Credit Guarantee Scheme
There are a vast number of startups and small-scale businesses in India. Notably, businesses employ different types of professionals and offer employment to them. Also, they are playing an essential role in boosting the economy of India. The majority of small-scale industries are engaged in manufacturing activities and export. However, they have a problem with lack of credit. Not having sufficient credit when it is most needed can cripple a business. Also, lenders may charge a high-interest rate if a business applies for a loan. Moreover, banks treat giving loans to a business as risky for fear of not getting their money back. Thus, getting a loan or funds may be challenging for a startup or a new entrepreneur.
The credit guarantee scheme is started by the Government of India together with the Ministry of Micro, Small & Medium Enterprises or MSME. It helps a business get collateral-free credit. The government of India started the credit guarantee scheme a few years ago. The credit guarantee scheme for startups was updated, and its revamped version was enacted on 1st April 2023.
How The Scheme Works
Existing and new businesses can apply for a loan under the Credit Guarantee Fund Scheme for Micro and Small Enterprises (CGTMSE) scheme. The government has formed Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) along with SIDBI. The trust will be responsible for the collateral. In addition, it will give the funds for the collateral and provide loans to startups. The faith will give guarantees to banks or lenders on behalf of businesses that apply for the scheme.
The lending bank or financial institution does not ask a business owner for a guarantee or collateral. The formation of the CGTMSE assures the bank that if the borrower or businesses don’t pay back the loan amount, it can recover the money from the trust funds. The banks are more confident in giving credit to startups and business owners when the trust takes responsibility for the collateral.
Benefits Of The Scheme For Startups
The credit guarantee scheme started by the Indian government allows business owners and startups to get credit without having collateral like property or any other type of guarantee. Getting a loan from a bank or any other lending authority is next to impossible because they need a guarantee of property or assets that assure them of a repayment method. Now, businesses can access credit from banks that are reluctant to give loans to SMEs. Moreover, a startup that cannot provide details and proof of its creditworthiness can apply for the credit guarantee scheme. Also, you will get credit even if you don’t have accounting records to show to the bank.
Notably, the credit guarantee scheme helps startups to avoid equity dilution for getting credit. Startups can get debt funding even if they lack collateral. In addition, it helps them diversify their funding sources. The scheme offers a stable source of revenue and liquidity assessed over one year.
Eligibility Criteria For Borrowers
- Firstly, new and existing micro and small enterprises can get finance under the credit guarantee scheme for startups. Also, a business should have a stable revenue capable of debt financing.
- Secondly, the startup applying for the scheme should not default or fall into the category of NPAs.
Businesses that have not defaulted to lenders or organizations of investments.
- DPIIT, or the Department for Promotion of Industry and Internal Trade, should recognize the business applying for the scheme.
- A business owner who applies for a credit up to a maximum of Rs. 5 is eligible to get credit.
- Any other guarantee scheme should not cover the credit facility.
- Lastly, if any member of organizations giving the collateral cover has certified your eligibility criteria, you can apply for the scheme.
Eligibility Criteria For Lending Institutions
- Scheduled commercial banks can give the loan.
- Financial institutions are eligible to give credit under this scheme.
- NBFCs registered under RBI with a rating of BBB and above and Rs 100 crore net worth can provide the loan.
- Alternative investment funds that are registered under SEBI are eligible to give credit to businesses.
Key Features Of The Credit Guarantee Scheme
- First, all cash or non-cash-based funds given as credit to borrowers are covered under the scheme.
- The scheme offers a maximum loan exposure of Rs. 5 crores to manufacturing, trading, and service businesses. The government backs up part of the loan (up to Rs. 5 crores). Above that amount, it will be an unsecured loan.
- Next, small finance banks and urban cooperative banks will provide a maximum cover of Rs. 2 crores. The revised coverage amount after 1st April 2023 also applies to the trading sector.
- Moreover, there are two models in credit guarantee schemes- the single model and the hybrid model.
- When a business doesn’t provide collateral, it comes under a single model.
- In a hybrid model, the MSE gives some assets as collateral to the lending institution. The government will cover the amount remaining after the collateral.
- Lastly, there is a higher chance of getting a loan under the hybrid model as you guarantee the credit you take.
Percentage Of Collateral Given By Government In The Scheme
The credit guarantee scheme covers 85% for up to Rs. 5 lakh exposure. The rest amount is unsecured, and the banks take the risk for that. The bank will scrutinize and check if a business is worth giving a loan or not.
85% cover is given to MSE run by a women entrepreneur, SC/ST, a person with a disability, ZED-certified businesses (zero effect, zero defect), Agniveer, and Aspirational districts. These categories will get an additional ten per cent discount on the annual fee.
80% of the credit is given to MSEs in the NorthEast region & Jammu, Kashmir, and Ladakh areas for a loan up to Rs—50 lakhs. This category will also get an additional ten per cent discount on the annual fee.
If some MSE in the abovementioned categories has taken a loan of more than Rs. 50 lakh, the government will give a cover of 75%.
Terms And Conditions Of The Scheme
- Collateral starts from the date a business pays the annual collateral fee.
- There are 2 types of loans – term loans and working capital loans. In a term loan, the guarantee is given till the period of the loan. In a working capital loan, the government gives five years of collateral starting when a business pays the fee. Startups can renew the collateral period for 5 more years.
- The annual collateral fee is 0.37-1.35%. The bank can charge an additional fee of its own for this amount.
- The maximum interest rate is 14% for bank loans and 18% for loans given by NBFCs.
- The lock-in period of the loan for banks is 18 months. For 18 months, the bank will not ask the government to give the money.
- The bank can ask for the guarantee within three years if a business becomes an NPA or for a higher lock-in tenure, whichever is higher.
- The lending banks and NBFC are responsible for recovering the loan amount from a business that applies for credit.
- The trust formed for the credit guarantee scheme will provide 75% of the collateral money initially upfront and give the remaining amount after the recovery proceeding. The trust will give outstanding interest on one quarter and not for anything else.
- The lender can claim the money the borrower has taken, and the government has backed up without undergoing legal proceedings for a credit amount of Rs. ten lakhs in case of an NPA. The lender can claim the money from the government.
Supporting Documents Needed For The Application
- You will need to provide your latest annual report.
- Businesses will have to give the undertaking after stamping and signing it.
- You will also have to provide documents for complying with the conditions and requirements of MLI registration.
Step-By-Step Guide To Applying For The Scheme
- Make a business plan that includes information on finances and business viability.
- You can select the bank or lending institution from which you have decided to apply for a loan.
- Submit your application to the bank. Also, you need to submit your business model.
- The bank will scrutinize your documents and verify the information.
- The bank will pass on your application to the trust formed by the government for the collateral. The trust will recheck and reverify your documents. After that, the lending bank will give the loan money to a business.
- After bank approval, the borrowing business needs to pay the annual fee.
Now that we have detailed information on the scheme, the credit guarantee scheme for startups is the best source of credit for MSEs. It gives you much-needed financial help when you don’t have any other source of revenue. Borrowers must check the eligibility criteria to know whether they can get credit under the scheme. The application process is easy; we have explained that in this blog. We encourage small and micro businesses to consider the benefits of this scheme and submit their application to an eligible lending bank for further process. Make a business plan, apply for the credit guarantee scheme, and start your business.