What does personalization mean in debt financing?



Personalization and personalization are the buzzwords which are the “holy grail” for the design of products and services. Marketing materials explain how that product or service is designed to meet your unique needs, which fits your budget perfectly and will keep you consuming it. What does personalization mean in debt products? Is it even possible?

Personalization is possible in debt products. The customizable features of debt financing are amount, price, repayment method, and security. There are a variety of combinations of these characteristics that are possible. However, we must understand that the personalization of debt must be done while keeping the risk profile of it.

The conditions for each company are unique – their own financial situation, i.e. availability of liquidity, leverage, consistency of payments by clients, timelines for project and cycle times. sales, the reliability of their suppliers, the availability of mortgage guarantees and relations with financial institutions. This means that a corporate borrower must either find a ready-made product that suits their situation or work with a lender who is ready to customize the product.

Here are some ways in which debt personalization can be done:

1. Amount

: Estimating the exact loan amount is important. It must find the right balance between the repayment capacity and the demands of the company. Ideally, the two should be in sync even if one of them is out of sync, this will not have an optimal solution for the business. Higher business needs but a lower repayment capacity would mean the need to finance the business with equity or to take out a loan allowing repayment over a much longer period if the risk profile allows it. Also, having a higher repayment capacity does not mean that the business has to borrow and incur unnecessary interest charges.

Sometimes lenders don’t want to lend smaller amounts and businesses are forced to borrow larger amounts than necessary. It is better to avoid such situations, or you can negotiate with the lender not to pay out the entire amount at one time. Instead, request an appropriate withdrawal period so that you receive the full amount over a period. The lender may charge you a commitment fee for this arrangement. Typically, this would cost a lot less than withdrawing the entire amount that you wouldn’t otherwise need.

The reverse can also happen. You may need more money, but the lender might not be willing to lend that amount. In such cases, you can negotiate a set of milestones on which the lender will pay the remaining amount. If you do not meet the milestones, the amount will not be disbursed. Flexibility can be built around the quantum by adding the pull frequency functionality.

2. Reimbursement model: A loan repayment schedule is a schedule of expected interest and principal repayments or payments over the life of the loan. Repaying specific amounts at specific intervals is an essential commitment of the borrower when taking out the loan. The payment is made up of principal and interest. Flexibility can be built around the principle of structuring in several ways.

The amount of repayment per installment depends on the length of the loan, with all other variables held constant. It is important to note that the shorter the duration of the loan, the higher the amount of the monthly payment, but this also decreases the cost incurred in the form of interest paid. The ideal term is one that fits your business cycle and smooths your cash flow. You may have options to pay all of the principal at one time (global repayment) at the end of a term, or a quarterly principal payment, or an IME or income-linked principal payments. These repayment schedules, if designed appropriately, can accommodate business seasonality

3. Adjustable interest: Sometimes the component of interest can also vary. The interest rate applied can be fixed or variable. The fixed interest rate as the name suggests remains fixed for the duration of the loan. Variable rates are tied to the marginal cost of funds (MCLR) -based lending rate and, therefore, the costs of the borrowing and repayment instrument fluctuate. Some companies like to set the repayment amount up front to plan cash flow, others prefer a variable rate to take advantage of policy changes. Typically, a fixed rate forces you to accept a higher rate or higher processing fee because it gives you complete certainty about how much you have to pay on each payment date.

At other times, the initial capacity of the business to bear interest charges is low but has a confirmed long-term backlog that will bring it significant income in the future – in this case, a low interest rate is charged during the term of the loan and an additional interest rate is charged at the end of the loan or an increase in equity is built into the term of the loan.

4. Amortization limits vs renewable limits: Basically, there are two types of loans – term loans which are where the principal is paid back systematically over the life of the loan and revolving loans which allow for multiple withdrawals and repayments and interest is only paid on the amount withdrawn. Sometimes your business can be highly dependent on order availability. Your indebtedness can only arise when you have larger orders and if not, you are able to run your operations well without any debt.

For such situations, which are typically faced by seasonal businesses or businesses based on B2B orders, a debt line with the ability to repay the amounts withdrawn once the need is over and then withdraw them when the need arises. feel. So even though the length of time for which you can avail the facility may be one year, you may be able to withdraw and repay the amount in (say) 3 months and then withdraw it again after a month for another 3 months. . In this case, you will end up only bearing the interest charges for 6 months instead of 12 months.

5. Prepayment: If you get a 24 month loan but get a large influx of money from a certain source, you may not want to continue with the full loan amount. In such cases, you may want to prepay and close the loan. However, in such cases the lender loses interest income for the remaining term and as a result some lenders have high prepayment penalties. One way to deal with this is to understand if you can predict when you will get a big influx of money. Depending on the schedule, you can initiate a blocking period with the lender, during which you will not prepay any amount on the repayment schedule and reduce the prepayment penalty over the remaining period.

There are many ways to customize loan products between the two spectra of fixed term loan and revolving credit. Sometimes only one type of product is available from the same lender. Therefore, there is a need for borrowers to consider partnerships with lenders who can customize and offer different types of product variants.

Customizing debt to meet the needs of a business is very important because it has long term implications for managing its cash flow. Bad debts due to poorly designed repayment schedules can have serious consequences on a company’s creditworthiness and its future fundraising capacity. The onus of providing the right terms and receiving the right terms rests on both the creditor and the receiver.

The author, Avishek Gupta is responsible for the Caspian debt. Opinions expressed are personal

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