Apohan Corporate Consultants Private Limited

Where businesses realize their dreams!!!


Disadvantages of Debt Funding

Introduction:

The biggest disadvantage of a bank loan is the fixed guaranteed periodic interest payment and repayment of the principal amount. Don’t understand circumstances of the business and any non payment is considered as default.

Remember these three words:

Fixed (or can be calculated) in amount

Guaranteed & can’t be denied

Periodic or following a given schedule agreed beforehand

Most critical drawbacks

Banks don’t look at the merit of the business, quality of the management or potential of the business sufficient criteria to lend. They must be provided some or other type of security or margin money which becomes a serious limitation on the amount of fund that can be raised.

Client is treated as if he himself is needy (or seller)

As an institutional lender, bank officers have very less flexibility in processing the loan applications and they may (& can) turn down and application even for frivolous reasons. They will not provide loans to new businesses or businesses with poor credit history. Technically, a business is a client of the bank but there is hardly any tendency to sell more.

Corruption

In India, there is good degree of corruption in the sanction process especially if you are new, or are in urgent need.

Defeat of the very purpose of corporate form of business

The corporate form of business is to basically segregates the the owners from the management of a company in terms of any rights and liabilities. But the bank requires the promoters and the directors or the shareholders to provide personal guarantees & putting their personal properties at risk. We can see a number of cases in the market, where the banks are auctioning the personal assets of many businessmen.

No distinction between wilful defaults & circumstance based genuine business failures

One more disadvantage of bank lending is that the banks cannot distinguish between wilful default and a circumstantial default. Their treatment of the good, bad and the ugly is the same. This leads to emotional and psychological distress of a genuine businessman. The plight of such honest businessmen is the last thing one would like to see. The phenomenon of these options discourages a layman from undertaking any business venture.

Difficult the times, difficult the loan

Another aspect of bank loan is that it becomes more difficult to avail any money in difficult times. So banks are only good weather friends. In the history of long existence of a business, they do suffer a once in a lifetime misfortune due to circumstances beyond control of management. The business is still very much viable if certain relaxations or or additional credit is provided. The worse the situation of a business, the worse the behaviour of a bank! Most of the times the behavior of banks is so weird that they themselves can be held responsible for making their accounts loss-making or liquidated!

No regard for business priorities

Payment to bank takes the first priority, and if a good opportunity is is passing by, the business cannot use its money to pursue that opportunity. Occasionally, this does cause a very serious opportunity loss to a business. Bank loan repayment in most of the cases must start almost immediately. For businesses with a long gestation period, this becomes as good as borrowing from the bank to pay the bank. Bank is simply not bothered with the cash flow situation of the seasonality of a business. They are very particular about the date of payment of the installment amount.

Difficult enhanced credit

Banks are very rigid when it comes to provision of enhanced credit or credit with second charge even if the value of the security has increased. The financial expertise is of the banks is of absolutely no use to a business. The rules of the banks are very stringent when it comes to to providing better terms on request of a borrower. It is most likely that most of such requests are rejected by the bank.

100% control with value destruction on default

One may lead to think that bang doesn’t interfere in the day-to-day operations, but when a business defaults the bank takes complete control of the business intends to be driven by the sole objective of realising its own dues without any regard to future of all other stakeholders of the business. A bank does not have business competence, and hence mostly fails to to sale the business as a going entity. This results in liquidation of a business resulting in huge economic value loss.

Protected entities

Banks are protected by a very solid legal framework and the entire machinery of the state for law and order is there hands to recover the dues. If you default, you have to become an “bank default expert” to manage what is happening & what can happen with you. Apart from this, banks have a galaxy of expert lawyers which you may not be able to afford. Be it an injustice by bank, be it a default by bank or be it a mistake by bank – it is tough to get justice in legal system.

Lending rules unrelated to your business

The banks have their own rules of sector exposure, single account exposure, etc. With the increase in Corpus of the loan amount, the process of bank loan becomes equally tedious as equity funding. The small local, rural, cooperative, district, urban, etc banks have relaxed credit norms but their interest rates are very high. This kind of disadvantages more or less apply to all other types of institutional lenders.

Other matters:

A complex variety of banks leading to wrong choice by new businessmen

A complex variety of lenders leading to capital structure issues

A complex variety of debt products increasing financial risk of a company

Limitation of facilities in local banks

Lack of custom communication

Lack of easy to understand communication

Benefit of bank taking priority in suggesting a product

Difficulty in shifting current account

No reduction in interest rate when project starts running & risk is reduced

No reduction in security till the end of term though outstanding is reduced

No facility of project finance

No flexibility of switching between schemes/ debt products

No passing on of repository rate cuts by RBI in time

A lot of income in the form of penalties & processing fees

Unprofessional attitude & behavior as money is not own, banks are kind of trustees of depositors

The  abnormal banks’ losses in NPAs resulting in increase in cost to good borrowers

No clarity for long on whether the sanction will happen despite taking huge documents

You may miss the eligibility for a weird reason though other factors more than compensate that shortfall of yours

There is serious limitation on lending to very very long-term but equally attractive investment opportunity

No ballooning or matching with company’s life cycle cash flow

Typically, in India, banks don’t provide soft & hard copy of draft contract for reading & legal vetting 7-days before

The credit policies of banks are confidential documents (or it is like you hiding your marketing brochures from customers)

The interest rate difference for the same business from various banks of same types can’t be logically explained

No formal negotiation process on interest, terms of contract, etc happens with written record though it is a normal (financial) transaction

There is nothing called a loan tender (though there is a bond market) to make banks compete for medium loan size, there is no competition led by buyers

It is neither the  duty of banks nor the culture of the banks to teach you banking or finance. You must learn it the hard way!

Apohan role:

Apohan helps a medium size business in negotiating the bank loan contract and having a successful borrowing strategy. However, unlike we provide end to end services in equity funding, we don’t provide end-to-end services for business loans from banks and other institutions or any private lenders. Apohan’s unique selling point is its ability to successfully generate equity funding, not loans. But we can best negotiate / bargain your loan contract before it happens.

Arun Joshi,

Chairman & Managing Director,

Apohan Corporate Consultants Pvt. Ltd.

Address:              Office No. 11, First Floor, Shriram Complex, Model Colony Road, Shivajinagar, Pune,

Maharashtra, India -411016 (Landmark – Fergusson College)

Landline:             +91 20   25650005, Mobile: +91 9810481325

E-mail:                 arun.joshi@apohanconsultants.com,  Website: www.apohanconsultants.com

Profile:                 https://www.linkedin.com/in/arunjoshiapohan

Company:            https://www.linkedin.com/company/apohanconsultants

Company PPT:   https://www.slideshare.net/ArunJoshi38/apohan-marketing-presentation-v47-02-062020-aj


Comparison of debt & equity

Comparison of debt funding & equity funding from business perspective:

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