NBFC NBFC Compliance

Compliance Requirements for Startups Seeking NBFC Funding

NBFCs have proved to be one of the major source points for startups in India and many other countries. NBFCs offer an alternative to traditional banks with more flexible and easily accessible routes for startups to raise capital. At the same time, with easier access to funds comes certain compliance requirements that the startups are supposed to follow while seeking NBFC funding.

In this blog, we will discuss some key compliance requirements that startups must address when approaching NBFCs to raise funds. Understanding these regulations will not only help startups gain easy access to funds but also ensure that they avoid any legal complications in the future. We will granulate the compliance landscape into different categories, such as regulatory requirements, financial requirements, and operational requirements, and simultaneously highlight best practices for startups desiring to traverse this complex terrain.

Understanding NBFCs and Their Importance

NBFCs are financial institutions that operate a variety of banking services without a license. They have gained prominence in recent times for start-ups and small businesses, given their easy going lending terms compared to traditional banks. The involvement of NBFCs accelerates the growth of a start-up ecosystem by infusing money into operations, expansion, and innovation. The main functions of NBFCs includes the following:

• Giving loans and advances.
• Acquiring stocks and shares.
• Leasing, hire purchase, and insurance services.

NBFCs are more appealing to startups, as they usually require less stringent prerequisites than their mainstream banks and offer quicker processing and more customized services. However, in order to obtain funding through an NBFC, a startup needs to check off a set of boxes for various regulations and guidelines.

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Understanding NBFC Funding for Startups

NBFC funding is similar to the bank loan; the only difference is that NBFC has less stringent terms that are far easier to comply with, primarily for startups still trying to fulfil the stringent depositary requirements set by banks and other financial regulatory bodies. Some of the financial products offered by NBFCs include the following:

• Term loans: Short-term or medium-term financing for working capital or an expansion.
• Working capital loans: A loan to provide funds to keep the day-to-day operations.
• Invoice financing: Cash advance against inflow invoices.
• Leasing of equipment and financing under a hire-purchase system: This is financing towards purchasing equipment or machinery.

Even with the apparent ease of accessing funding by NBFCs, startups need to comply with a number of compliance standards in order to access funds and function smoothly.

Requirements for Startups to Seek NBFC Funding

When going for fund requirements with an NBFC, startups must follow several compliance requirements to sanction funds smoothly and successfully. Therefore, some of the key compliance requirements for startups seeking NBFC funding are as follows:

Register Business and Organize its Legal Structure

A startup should be registered as a legal entity in the place where it wishes to operate before applying for reputable funding. For example, an Indian startup can be registered as a Private Limited Company, Limited Liability Partnership (LLP), or in any other valid form. NBFCs recognize the criteria to ensure that the startup is formally recognizable and operates within the legal framework of the respective country. Key documents include:

• Certificate of Incorporation or an equivalent document.
• Memorandum of Association (MoA) and Articles of Association (AoA).
• PAN (Permanent Account Number) and TAN (Tax Deduction Account Number) for tax compliance.

KYC (Know Your Customer) and AML (Anti-Money Laundering)

The KYC and AML regulations that NBFCs are required to follow are stringent. Hence, the customer’s identity needs to be verified thoroughly to ensure that the funds are not being used for unlawful activities. Startups must provide detailed KYC documents for their founders, directors, and major stakeholders. Commonly required KYC documents include:

• Aadhaar Card or Identity proof equivalent to the same.
• Passport, Voter ID, or Driving License for proof of address.
• PAN card for tax-related identification.
• Bank account details of the founders or the company.

As far as KYC is concerned, startups have to meet AML standards. Therefore, they must ensure that all their funds and transactions are transparent, well documented, and not involved in illegal activities.

Adherence to Credit Rating and Assessment Criteria

NBFCs assess a startup’s creditworthiness by examining its financial statements and credit history, among other business documents. To qualify for funding, startups must have a good credit rating and meet specific financial eligibility criteria. Key documents NBFCs review include:

• Income statements and balance sheets for the last few years.
• Cash flow statements indicating liquidity and operational efficiency.
• Profit and loss statements are used to evaluate financial health.
• Debt and equity ratio to determine leverage.

For startups, positive cash flow or demonstration of growth potential is important since NBFCs bank based on these assess repayment capability.

Financial Audits and Disclosure Requirements

Transparency in all matters relating to financial institutions is the key, and a startup should always maintain proper books of accounts and updated records. NBFCs normally ask for audited financial statements relating to the company to maintain authenticity and reliability. Start-up businesses should maintain and provide the following:

• Certified accountants conduct general financial audits regularly.
• Provide tax returns for at least the past two or three years.
• Ensure they comply with GST (Goods and Services Tax) and other relevant tax requirements.
• Keep appropriate records of financial transactions and business deals or transactions.

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Sector-Specific Regulations for Startups Seeking NBFC Funding

Besides general requirements for compliance, some industries have further regulatory imperatives. Therefore, sector-specific regulations for startups seeking NBFC funding are as follows:

• Fintech startups have to adhere to the regulations prescribed by the SEBI and IRDA.
• Healthcare startups are required to follow the guidelines provided by the Ministry of Health.
• In India, e-commerce companies shall also be protected under the Consumer Protection Act of 2019.

Knowing and understanding which regulations control your industry is very important. This helps ensure compliance and aids an organization in securing its NBFC funding.

Best Practices to Ensure Compliances by Start-ups

A few of the best practices that can help a startup simplify the process of compliance are listed below:

• Engage a compliance officer or retain legal counsel to oversee regulatory matters.
• Regular audits and financial statements should be kept up to date.
• Utilize the accounting software to make the process of tax filings, financial disclosures, and reporting smoother.
• Go through the updates in RBI and sector-specific guidelines from time to time in order to avoid non-compliance.
• Build a strong relationship with the NBFC to clarify compliance requirements and address any concerns early in the funding process.

Future of Funding for Startups through NBFCs

NBFCs will remain vital in the funding ecosystem for startups. Once the regulatory environment evolves, easier processes can provide increased transparency and flexibility, which in turn will make it easier for startups to access capital. Innovations in fintech and digital lending platforms are also smoothing the compliance process and enabling startups to obtain funding from NBFCs with greater ease.

Conclusion

NBFCs have been an invaluable source for the initial fund requirements of startups, providing flexibility around funding that accelerates growth and innovation. However, NBFCs must ensure that the loans they offer comply with business registration, KYC, credit check, financial disclosure, and regulatory guidelines of RBI. Keeping themselves up-to-date, maintaining proper financial books and records, and following best practices will help the startup navigate most of these issues effectively and harness the real power of NBFC funding.

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