Entrepreneurship @ Club 40 MENTAL : Bankers Perspective

Well, the culture of start-ups and entrepreneurship is brewing in the country and financial sector (specially venture capital world) has gained unparalleled experience of supporting this class of business enthusiasts. There are plenty of successful stories about the people having passion for entrepreneurship, volcanic spirit to conquer the markets and benefiting the society with their innovative products and services.

Governments of India’s (GoIs) efforts in this direction to encourage and support entrepreneurship are also laudable. Government has launched many schemes like Stand Up India, Mudra Loans, and other MSME loans etc. By effectively monitoring the schemes and ensuring successful implementation, we must appreciate that GoI has walked the talk on this front. As per reports, Government has ensured disbursement of about Rs.2.20 lakh crore during FY 2017-18 in support to MSME by way of Mudra Loans, and 2018-19 Budget has increased this target to Rs.3 lakh crore. Budget 2018-19 has also made provision of Rs.3794 crore for MSMEs for providing credit support, capital and interest subsidy and innovations in this sector.  There are other initiatives also like Fund of Fund by SIDBI for (Corpus Rs.10,000 crore) contribution to various Alternative Investment Funds (AIFs) for facilitating funding needs for Start-ups through participation by VCs.

In a conductive policy environment, it is also a fact that the banking industry in the country is facing highest levels of NPAs (about Rs. 8 lakh crore) and there is defeating confidence in lenders in supporting existing businesses. The credit off-take is tepid despite all policy efforts are being made to encourage industrial lending. Banks in the country have been tending in funding well established business models based on traditional collateral/mortgaged based funding. Therefore, funding to fresh entrepreneurs coming out of campuses does not come easy to them. It is in light of this that the entrepreneurs starting their ventures in their 40s may have some advantage in having the bankers on their side.

This club 40 has many traits which a lender would be looking for in experimenting with start-ups lending. Mostly the people coming in this class have huge 15-18 years of experience (EXPERIENCED) of running factories/organizations, dealing with people, showing their leadership skills (LEADERSHIP), experimenting with products/services/technology (TESTED) etc. They have the advantage of knowing the deficiencies in the existing business models and the right vacuum to be filled up. They carry a good market reputation and relationships (NETWORKED) which support them in taking forward their new ventures. Their maturity level also supports them in taking calculated risks (MATURED). They have bitter taste of non performance and know how to cope up with tough situations. They have knowledge of their market and possess quality of being aggressive to capture the same (AGGRESSIVE). Many of the entrepreneurs in this group also do not face issue of initial seed capital support due to their available savings.

This class is expected to be able to convince not only the investors but also the lenders with their credentials in getting the right kind of capital for supporting their business ventures. The VCs in the market have already experimented with the earlier class of freshly young entrepreneurs coming out directly from their colleges. Now these VCs as well PEs are looking forward to balance their investment portfolio with seasoned experienced professionals aspiring to come out from their cabins.

With the corporate segment funding being in low confidence, banks are eying other segments where they can develop business. Affordable Housing and MSME are the key sectors which banks are targeting at this juncture. The confidence given by Mudra Loans, Start ups Loans etc. have created positive vibes where banks seems to be now looking beyond collaterals for these small/medium loans and may experiment with ventures giving sustained outcomes backed by these matured class of entrepreneurs. As compared to equity capital, the debt capital has its own advantage for entrepreneurs since it does not require them diluting stakes during the initial stage when it is valued low, and provides freedom of experimenting without any outside intervention. The 3Cs of Credit (Character, Capacity and Capital) seem to be favoring MENTAL (Matured, Experienced, Networked, Tested, Aggressive, Leaders) of Club 40 with not only banks but also NBFCs and other institutions coming forward with MSME/Start-ups oriented debt products specially targeted towards entrepreneurs. Just to cite, there were about 27 public sector banks, 18 private sector banks, 31 NBFCs, 31 regional rural banks, 13 state co-operative urban banks, 73 micro finance institutions as of March 2017 partnered for Mudra loans, and the list is expected to further grow. Hence, Club 40 @ MENTAL may look forward with lenders supporting their ventures without the need for compromising and diluting stakes. Budding entrepreneurs may follow some of the under given suggestions while looking for financing from banks:

- Many banks have specialized branches for SME/corporate lending. Some of the banks have even opened dedicated branches for Start-ups. Hence, find out the right branch for your funding requirement and approach the right officer.

- Find out if the bank has any specific format/details in which proposal needs to be submitted. It will save lot of time.

- Find out if there is any specific subsidy/grant or interest relaxation etc. provided under any central/state government scheme for funding of product/service/MSE in which your firm can be categorized. Try to get financing under these schemes which may save cost.

- Submit an executive summary of proposal having about three to four pages that should mainly provide basic details of the borrower, experience, cost and sources of financing, repayment sources, key financials, key strengths and present status.

- Submit a detailed proposal that should explain about the management aspects, market, technical aspects, projected financials along with assumptions and basis for the same. Support proposal along with copies of quotations received, any supporting report relied upon, registration certificates/licenses, validation/viability/appraisal reports, three years IT-returns, valuation of any collateral offered, client testimonials etc.  Additionally, supplying soft copies of these documents to the assessment officer may expedite processing.

- Club 40 must emphasize their past experience, successful track record, reputation and ability to drive up the proposed Start-up as future success story.

- There is growing interest in banks also in funding Start-ups in order to develop future business and branding opportunities with them. Hence, while discussing/submitting your proposal highlight advantages (in terms of future business, cross sell opportunities, payroll accounts, retail business opportunities and branding etc, if any) to the bank in associating with your Start-up at its nascent/present stage.   

- Do not rely on one bank/institution. Submit your proposal to at least 3-4 banks.

- Be in regular touch with the assessment officers and supply them any additional required information.    

Letter of Undertaking (LoU) / Letter of Comfort (LoC) Ban and Impact

The scam based on misuse of the system of Letter of Undertaking (LoU) issued by banks in India has created a setback for the lenders and regulators in the country. The incident has affected the lending confidence and raised questions on monitoring and compliance. It has recently resulted in ban of LoUs and Letter of Comfort (LoCs) instruments for trade credits for imports in India by the banking regulator. The regulator has kept the use of Letter of Credits (LCs) and Bank Guarantees open for trade credit imports (subject to compliance with the provisions). More clarity is expected to emerge from regulators in future on trade facilitation through LC/BG. Much is being talked about the ban since its announcement. While industry bodies have complained of liquidity crunch, possible defaults, profitability impact etc., its supporters have claimed that now the financial system would be more opaque and restriction will help in improved discipline.

In the above context let’s have a simple case analysis how and why LoU/LoC come into the process:

Company XYZ is in a business where it needs to import some raw materials (RM). It has a cash credit facility sanctioned from its bank at rate of interest say of 9% p.a. and also has sanctioned LoU line.

It issues a import order to the supplier and on the date of payment, has two options (subject to its operating cycle) : (1) Use Rupee based cash credit (CC) facility at 9% p.a., buy foreign exchange (FC) and make payment (2) Provide LoU from the bank to a foreign bank outside India (or foreign branches of Indian banks) and avail foreign currency (say USD) short term loan @ 3.5% p.a. (plus some marginal LoU commission), and use the loan (say 3 months tenor) for payment to supplier. By the end of 3 months, make finished goods from the RM sourced, supply it and realize revenues. Use revenues to make repayment of FC loan. Thus, XYZ Co. got saved from using the comparatively costly Rupee based cash credit facility for 3 months, resulting in huge saving of 5.50% interest cost (excluding the hedging cost if not naturally hedged). The saving in cost not only resulted in improving profit margins but also helped in remaining competitive in the global market where competitors have access to low cost funding. Additionally, the unused Cash credit also helped in readily available stand by line for managing liquidity. 

XYZ Co. has been continuously working under the above mentioned two options depending on its need and managing its business, cashflows and liquidity. Now, say XYZ had planned its payments to suppliers under the option two above while managing its liquidity. But on the date of making payment to supplier, its bank refuses to allow using LoU line (due to regulatory ban or uneasy market conditions). Its a catastrophe like situation for XYZ because its cash credit line might be already fully used (or planned for other different payments) and has no other freely available cash flow. This results in loss of market reputation, affects the whole business cycle, business goes for a toss and XYZ defaults to its lenders and creditors.

It would not be difficult to say that in the absence of LoUs, companies like XYZ can plan their business with the other available cash credit, short term/long term loans, ECB loans and bank guarantees etc. other products depending on guidelines. However, unplugging LoU suddenly has a heavy bearing on any MSME or Mid/Large corporate and they can be devastated. Hence, it is clear that it would have been better if six to nine months time was provided to corporates before banning LoUs so that they could adjust to the new situation and manage their cash flows. Not providing sufficient time may increase stressed accounts in banking industry which is already suffering from mounting NPAs.

As per Department of Economic Affairs (DEA), Ministry of Finance (MoF) data, the short term external debt of the country as on September 30, 2017 was about USD 93 billion of which USD 92 billion was related to trade credits. Of this, USD 60 billion has maturity between six months to one year while USD 32 billion has maturity within six months. With such huge size of trade credit debt, discontinuation of significant instruments like LoUs could create mayhem in the credit and forex market. With the unexpected ban on LoUs, corporate will have unplanned need of buying foreign exchange for either paying to suppliers or to foreign lenders (since not being allowed to roll over LoUs now). This is expected to create pressure on Rupee in near term because the planned payments at a distance of six to one year will now fall for payment immediately. Their hedging, forward booking etc. and all other planning may go to toss and it may also create additional cost burden. Already regulator has been pushing hard corporates in taking action for hedging their foreign currency risk. Corporates would be discouraged in the hedging expenditure in future when these planning fail.

Resorting to the other options in a severely affected banking industry fighting with NPAs and low confidence on credit side would not be easy. Further in this credit tight scenario, sanction of any fresh loans/facilities takes time, followed by other procedures like documentation, charge creation, pre disbursement compliances, collateral arrangements etc. LoUs/LoCs have been one of the key businesses of the off-shore banking units of the Indian banks in abroad. Ban on this business would also affect profitability of these centres.

Government has supported by many schemes improving competitiveness of Indian businesses in the globalized trade. Increase in the cost due to ban of LoUs/LoCs would result in demand for other subsidies and schemes from government by corporate India in order to survive and remain competitive. Any such new scheme will have bearing on tax payers money.

Technology development in banking sector is in advance stages and various new concepts like artificial intelligence and block chain are reported to be supportive in conducting a safe and secure trade finance business. It would have been better that when banks have learnt a painful lesson from the LoU fiasco, they could be encouraged in adopting these new technologies in order to facilitate safer and faster business. 

(Note: Views expressed are Personal)