Starting a new project without tying up working capital – A suicidal act for SMEs

Starting a new project without tying up working capital – A suicidal act for SMEs

by anil

Many SMEs start a new project by taking a term loan and for working capital, they count on the assurance of banker to sanction at later date which is suicidal if not materialised.

Recently, I met an entrepreneur from Gulbarga who had set up a dal processing unit and which remained in the standstill for four years. He has been running a small business which was taking care of all his needs and also over the period of years, he has accumulated savings to fund his dream project of setting up a dal processing unit in Gulbarga. The region is very much known for producing a huge quantity of pulses, mainly Toor Dal.

The region is identified for promoting Dal Processing business by MSME ministry. The region has a well-established ecosystem for dal processing business and hence business model is clearly visible, less risky and thus there is little scope for error in setting up the business.

The promoters have experience in this line through their active involvement in the trading side and hence know the purse of the business.

As he was brooding over the plan to set up the unit, one day he was approached by the local bank manager with a proposal to fund his project if he is seriously exploring. Excited at the encouragement, the entrepreneur decided to take a plunge. He applied for a term loan of Rs 50 lakhs and working capital of Rs 50 lakhs for setting up a modern dal processing unit.

The Bank Manager suggested him to take term loan now and start construction of the unit. He assured to sanction working capital of Rs 50 lakhs when the unit becomes ready.  Trusting the Manager, the entrepreneur chose to overlook the need to have a sanction of working capital. The manager was enjoying goodwill generated in his benevolent act of offering to finance the project at the beginning.

When the project got closer to completion, the promoter approached the bank for sanction of working capital. However, by the time, the Manager got transferred. The new incumbent did not evince interest to act fast and help to facilitate starting of operation.

By the time the unit is ready, there is no working capital to begin operation. The branch manager was cold to repeated requests and pleadings. Rather he started demanding repayment of term loan instalments which become due as per the sanction.

The entrepreneur made many trips to branch and their controlling office for months and months. There was no response to his requests though they are sympathetic. However, they had been demanding their instalments to avoid classifying the loan as NPA.

The promoter tried other options like job work to keep the unit running and recover fixed expenses. However, the nature of the business is such that job work is not remunerative and it requires one to buy the raw materials and sell the finished goods.

Now the bank has initiated the recovery proceedings. Recently they have issued the notice under SARFAESI Act for no fault of himself nor the project has failed due to viability related issues. The entrepreneur is groping the dark.

The key takeaways are :

The promoter erred in not tying up funds before  beginning the implementation:   

The project report clearly mentioned the need for working capital of Rs 50 lakhs along with the proposal for a term loan of Rs 50 lakhs for the project.

It is not uncommon to find such instances among the SMEs in India to initiate the new project without a proper financial plan and or without tying up the funds. Many well-established firms also commit the same mistakes.

A debt-funded business venture needs to be initiated very carefully by analysing the sufficiency of the loan at the beginning. Any disruption or under-financing will have a cascading impact on the project as well as entrepreneurs himself. It not only renders the project unviable, it will also make life miserable to entrepreneur himself. Credit Records of all (borrowers/guarantors ) will be affected.

Normally any project outside CGTSME ambit, banks tend to seek sufficient collateral security and obviously, entrepreneurs are compelled to mortgage assets like the house. Sometimes parents or siblings also extend the properties for the loan. The situation like the one narrated above, if happens, it will engulf entire extended family and will remain a perennial source of distress at home and in the social circle if the project fails for any reason.

Entrepreneurs should deal with Bank professionally and ignore assurances however appealing:

Promoter believed in the assurance of Branch Manager to sanction the working capital once the unit is ready. Though sounds not entirely incorrect at the personal level, the fact of the matter is that the branch manager is part of a large organisation and subject to transfer. Secondly, the institution may change their lending policy so that new incumbent may not show inclination though it is incorrect to deny working capital facility.

I have come across many instances where bank staff at the lower level advises the clients borrow lesser amount now just to ensure that the proposal falls within their delegated power. They assure to obtain the sanction for balance requirement at a later date. It may be with the good intention to help entrepreneurs to secure funding to kick-start the execution; however, it is fraught with the danger of not getting the assured sanction for a variety of reasons.

Conclusion:

Venturing into the execution of any project without proper financial arrangement is fraught with risk of under-financing and likely to face recovery action without the project being tested for viability. The entrepreneurs should stay away from such misadventures.

 

 

 

 

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