Embarking on growth without financial plan- A fatal blunder seen in many SMEs in India

Unplanned approach to fund-raising to finance the growth is fatal to SMEs. A meticulously drawn financial plan which is sensitive to economic viability and entrepreneur’s financial strength can help to avert disaster in growth stage

Recently I met an entrepreneur friend after three years. In 2013  Then he approached me for guidance on seeking a small loan from his bank wherein both manager and himself could not agree on the approach to structure a loan to fund his business needs. Later he could get the loan after resolution of the contentious issue.

When we met recently, I was astonished by his fatal blunders committed while undertaking expansion of his business. He approached the same bank with the proposal which they have turned down. Later he approached many NBFCs seeking an unsecured loan to and stitched a funding plan involving many NBFCs to set up a manufacturing unit.

Bank did not consider his proposal because he sought enhancement in working capital which was beyond his eligibility level (to finance the factory). He did not seek term loan because he found it was a hassle and secondly he wanted to buy second-hand machinery which he had an apprehension that bank may not finance.

As bank turned down his proposal for increasing working capital, he started exploring sources elsewhere. He was approached by some brokers who work selling unsecured loans on behalf of NBFCs. They structured funding into many unsecured short-term loans of small amount and applied at a time to all. That is how he secured funding to set up his factory.

Still, the amount was not sufficient and he took high-cost hand loans from local money lenders.

Though the plant was set up and prosecution was started, the instalments commitments were too much to sustain for the cash flow from the operations. The pressures from lenders started rising. In the meantime, the working capital limit which was running satisfactory went out of gear. Most part of the day went in firefighting than giving any meaningful attention to securing business and increasing the capacity utilisation.

Recent demonetisation came as the body blow for already stressed business as his products are meant to real estate industry which is reeling under liquidity crisis.

Now he came to ask me how to save himself from distress which is appearing. The distress is more worrying because he has pledged his only house property to the bank and he had issued cheques to unsecured loans.

What are the key issues in the above case?

  1. Lack of proper financial model for expansion plan
  2. Diversion of short-term funds to building factory instead of raising long term loans
  3. Raised loan at an exorbitant rate of interest
  4. Failed to take banker into confidence with whom he enjoys excellent relationship
  5. No provision for contingent events like demonetisation
  6. No attempt to ring fence the family from business risks

Details as below:

1.Lack of proper Financial Model for Expansion plan:

We observed that entrepreneurs turn reckless and irrational at the time of undertaking growth decisions than at the start-up stage. The frugality and prudence (which are the hallmark of any successful startup) are thrown to the wind and blindly they choose to follow others without a proper plan. We had discussed these concerns in our following blogs:

Please read: Financial Planning

                     Planning for growth: How Prepared you are?

2. Diversion of short-term funds to building factory than raising long term loans:

Factory brings in income over long periods of time and should be funded with long-term resources either own funds or long term loan.

However, we have been seeing many entrepreneurs are drawn themselves into diverting short-term working capital funds to factory construction or even raising the short term unsecured loan to meet the construction costs without applying mind on how they will be able to service.

In the instance case, he should have matched the long term cash flow and repayment obligations before deciding on the nature of loan facilities.

Please read: 10 Questions to Answer Before Applying for a Bank Loan

Also please read: What is Sustainable debt level for my business?  

3. Raised loan on the exorbitant rate of interest:

The rate of Interest is very high obviously due to they being unsecured loans and hand loans. There is need to calculate the affordable rate while borrowing loans.

The unsustainable rate of interest will eat away thin margin which normally SMEs are getting.

4. Failed to take banker into confidence with whom he enjoys excellent relationship:

The particular entrepreneur has been enjoying good banking relationship with his existing banker.

Instead of asking for enhancing OCC limit he could have discussed with the banker about his needs to set up a factory. Since the existing turnover was not sufficient to increase the limit, he went way to unsecured sources.

The best course was to discuss the full pan to set up the factory and limitations like (buying second hand machines).

Entrepreneurs should not try to resort to short cuts. More elaborate planning and execution eliminates or mitigates lot risk in growth stage.

Having good relationship he should not have ignored them while expanding business.

Please read: Few considerations to keep in mind when your business has financing needs

5. No provision for contingent events like demonetisation

Contingent events can cause irreparable damage to sustenance of a business. In the present context of globalizations, there is no segment or sector which not affected by the changes happen in the world or within country. The economic environment has turned very unstable.

The best strategy is to hold lager contingent fund to stave off any a crisis due to contingencies, which are beyond control. In any expansion plant it is better to hold 10% of project cost as provision for contingencies.

Secondly if you have limits with existing bankers, in such contingencies, you would get regulatory support to seek restructuring of loans under RBI guideless (RBI/2015-16/338 FIDD.MSME & NFS.BC.No.21/06.02.31/2015-16 dated 17 march 2016)

6. No attempt to ring fence the family from business risks:

It is common mistake among entrepreneurs that they continue to expose family to increasing magnitude of risk as business grows. Normally it is happening due to pledging all the assets to secure the loans for business.

Though the assets are expected to be  pledged, there are many other measures such as taking term insurance and registering under Married womens’ act 1874 to support the family in the event of anything happen to entrepreneurs.

What is the remedy? How entrepreneurs should overcome these stress points?

The best course for growth transition always start with proper strategic plan. It may sound too sophisticated but growth plan must be charted with greater control on various dimensions. One must remember that growth is more challenging and riskier than start up stage.

We recommend that SMEs may retain a independent professional Financial advisor who is not seller of any products nor work at the behest of banks/NBFCs or other interest groups. He can guide to structure the growth plans which will eliminate blind spots.

Please read: Why SMEs need professional Financial Advisor

At least pause and review your own strength, Weaknesses, Opportunities and threats with reference to growth plan

Please readSWOT Anaysis- An Instrument for Sustainable Growth Planning


Haphazard approach to fund raising to finance the growth is very fatal to SMEs. As we have emphasised in other blogs, growth must be approached with meticulous plan and prior financial closure. The types and loans and or capital must be aligned with cash flow characteristics of proposed project.