Navigating Loan Sanction Terms: A 9 Step Guide for Micro and Small Enterprises

Careful understanding of Sanction Terms and Conditions as mentioned in Sanction Letter is important for all types of borrowers, it is however more important for Micro Small Enterprise to scrutinize the terms and conditions due to certain limitation faced by them which includes time, availability of qualified human resources in their enterprise and limited subject matter expert support MSE’s for fund raising. Here are few important aspects to be seen in sanction letter before acceptance :

1. Interest Rates & Fees

• Check the interest rate: Ensure it is competitive and fixed or variable rate of interest and whether interest is charged on daily reducing ,monthly reducing, annual reducing or fixed rate of interest.

• Processing Fees and Charges: Verify any upfront processing fees, legal fees, or other periodic charges.

2. Repayment Terms

• Tenure: Confirm the tenure of the loan and repayment schedule (monthly, quarterly, etc.).

• Prepayment Penalties: Check for any penalties for early repayment or foreclosure.

• Moratorium Period: If applicable, ensure the moratorium period is clearly defined and favorable for your cash flow needs.

3. Security & Collateral Requirements

• Type and Value of Collateral: Clearly understand what assets are being pledged/hypothecated/mortgaged as security.

• Personal Guarantees: Check if personal guarantees are required from promoters or directors and understand the implications.

4. Covenants and Conditions

• Financial Covenants: These include maintaining specific financial ratios (e.g., Debt Service Coverage Ratio, Current Ratio). Ensure they are achievable and not overly restrictive.

• Operating Covenants: These may impose restrictions on dividends, additional debt, or certain business activities. Review these carefully.

5. Disbursement Schedule

• Conditions Precedent: Understand the conditions that must be fulfilled before the funds are disbursed which is usually called as pre-disbursement condition.

• Phased Disbursement: Check if the loan or investment is released in phases and under what conditions the same will be released. Adequate vendor payment schedule should be worked and mentioned in Purchase Order/Contracts so that disputes can be avoided in future

6. Penalties and Defaults

• Penalty Clauses: Understand the penalties for late payments, defaults, or breaches of covenants.

• Events of Default: Clearly identify what constitutes an event of default and the consequences.

7. Utilization of Funds

• Purpose of Loan/Investment: Ensure the usage of funds is clearly defined and aligns with your business goals.

• Monitoring of Fund Use: Some institutions may require regular reporting or auditing of how the funds are being used. Proper accounting and record maintenance is required so that external agencies can verify the same and recommend release of funds at the shortest possible time.

8. Legal & Compliance Considerations

• Legal Review: Always have a professional review the term sheet or sanction letter to ensure there are no hidden clauses or unfavorable terms.

9. Amendment Provisions

• Flexibility in Terms: Ensure that there are provisions for amendments to the term sheet or sanction letter in case of unforeseen changes in business circumstances. However, in case few terms and conditions are not favourable seek for amended sanction letter before acceptance of the same.

In conclusion, when accepting sanction letter, MSEs in India must approach the agreement with a clear understanding of the financial, legal, and operational implications. By carefully aspects as mentioned above, MSEs can ensure that the sanction aligns with their business goals and financial capabilities. Engaging with professionals to negotiate favorable terms and ensuring compliance with all regulatory requirements are critical steps to safeguard the future of the business. Thoughtful consideration of these factors will enable MSEs to secure beneficial funding while minimizing risks and avoiding potential pitfalls.