We shall discuss a variety of debt schemes available for businesses, including External Commercial Borrowing (ECB), Venture Debt, Trade Credit, and Bill Discounting. These debts assist organizations to raise capital without ceding control or equity.
External Commercial Borrowing (ECB)
External Commercial Borrowing is defined as income earned through loans from abroad. It enables access to funds in foreign currencies such as USD, GBP, and EUR.
Forms of ECB:
– Bank Loans
– Buyer-Supplier Credit
– Convertible/Non-convertible Debentures
– Preference Shares
Benefits of ECB:
– Capacity Expansion: Useful for expanding existing facilities, like the opening of other factories.
– Company Acquisition: Enables take-overs of other corporations.
– Long-term Finance: Finances infrastructure projects for long periods, 15–20 years.
– Cheaper Funds: Foreign borrowing is at a low interest compared to domestic ones.
ECB Criteria:
Limits on borrowing are set individually based on the kind of business (for example, with software companies, the limit is up to 200 million dollars minimum).
The minimum maturity period is 3 years (or 5 years for sums greater than 20 million dollars).
Venture Debt
High-net-worth individuals and venture capital funds often finance established businesses looking for more funding without diluting equity.
Key Features:
Higher Interest Rates: Typically, around 12-18% a year.
Non-dilutive Financing: Since no equity needs to be given up, it is appealing to founders.
Short-to-medium Term: Loans generally have a duration of 3-4 years.
Eligibility: Companies that are not cash flow positive can still obtain venture debt.
Benefits:
Venture debt is appropriate for companies that are already backed by venture capital, but do not wish to dilute their equity more.
It allows businesses to shift between equity portions or expand without additional relinquishment of control.
Notable Players:
- Alteria Capital
- InnoVen Capital
- Trifecta Capital
Trade Credit
Trade credit is the oldest type of lending against goods and services where businesses obtain the advantage of purchasing items on credit from suppliers.
Key Features:
Flexible Payment Terms: Example includes a 20% payment upfront, while the rest is paid in 60-90 days.
No Interest: Trade credit usually doesn’t charge interest, as long as payment is made within a set time.
Accounts Payable: It will show up like any other loan as accounts payable on the balance sheet.
Benefits:
Improves Cash Flow: This is very helpful for companies because the flexibility allows them to purchase goods without immediate payment and sell them beforehand.
No Interest Cost: Non-payment of interest on trade credit helps businesses to spend the money on other important goods or services.
Bill of Exchange Discounting (Factoring)
Bill discounting permits provided by banks to corporate clients whereby against accounts receivable, instant cash is made available from a bank is also known as Factoring.
How It Works:
Illustration: A company sells goods for Rs. 100 to a buyer, allowing the buyer to pay in sixty days. Instead the company can discount its bill with a financial institution to receive cash immediately.
Benefits:
Instant Liquidity: Provides liquidity to the businesses that need to pay for expenses even when funds are pending from clients.
No Fixed Asset Requirement: Unlike conventional borrowing, Bill discounting does not require fixed asset as a loan collateral.
Institutions Providing Bill Discounting Facilities:
IFCI
Key Takeaways
- For Economically Active Businesses, Selecting The Right Debt Category Is Very Important: As a rule of thumb, different types of a business and the stage of its development require a specific debt scheme.
- ECB For Long Term Projects Such As Infrastructure Development And International Mergers: ECB is useful if the organization is expanding infrastructure or if there is an international merger.
- Use Of Venture debt for Early Stage Funded Companies: Venture backed companies without diluting equity can raise funds in early stages through venture debt.
- Improving Cash Flow With Trade Credit: Trade credit increases the cash flow cycle thereby resulting in more time to remit payment to suppliers.
- Procure Immediate Saleable Capital Using Bill Discounting: If there is working capital required urgently, but there are bills that are yet to be paid, bill discounting can be used.
- On understanding these models and applying them to your business planning, you can significantly enhance your financial liquidity as well grow your company. You should contact the RBI for reconciling the specific details regarding eligibility and limits of the ECB.
