Long Term Financing Definition Top 5 Sources Examples

Long-Term Financing Definition

The fundamental principle of long-term finances is to finance the strategic capital projects of the company or to expand the company’s business operations.These funds are normally used for investing in projects that will generate synergies for the company in the future years.E.g.: – A 10-year mortgage or a 20-year lease LeaseLeasing is an arrangement in which the asset’s right is transferred to another person without transferring the ownership. In simple terms, it means giving the asset on hire or rent. The person who gives the asset is “Lessor,” the person who takes the asset on rent is “Lessee.”read more.

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Long-Term Financing (wallstreetmojo.com)

Sources of Long-Term Financing

#1 – Equity Capital

It represents the interest-free perpetual capital of the company raised by public or private routes. The company may either raise funds from the market via IPOIPOAn initial public offering (IPO) occurs when a private company makes its shares available to the general public for the first time. IPO is a means of raising capital for companies by allowing them to trade their shares on the stock exchange.read more or opt for a private investor to take a substantial stake in the company.

There is a dilution in the ownership and the controlling stake with the largest equity holder in equity financingEquity FinancingEquity financing is the process of the sale of an ownership interest to various investors to raise funds for business objectives. The money raised from the market does not have to be repaid, unlike debt financing which has a definite repayment schedule.read more.The equity holders have no preferential right in the company’s dividendCompany’s DividendDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more and carry a higher risk across all the buckets.The rate of returnRate Of ReturnRate of Return (ROR) refers to the expected return on investment (gain or loss) & it is expressed as a percentage. You can calculate this by, ROR = {(Current Investment Value – Original Investment Value)/Original Investment Value} * 100read more expected by the equity shareholders is higher than the debt holders due to the excessive risk they bear in repayment of their invested capital.

#2 – Preference Capital

Preference shareholders carry preferential rights over equity shareholders in terms of receiving dividends at a fixed rate and getting back invested capital Invested CapitalInvested Capital is the total money that a firm raises by issuing debt to bond holders and securities to equity shareholders. Invested Capital Formula = Total Debt (Including Capital lease) + Total Equity & Equivalent Equity Investments + Non-Operating Cash
read more in the company if the same is wound up.It is a part of the company’s net worthCompany’s Net WorthThe company’s net worth can be calculated using two methods: the first is to subtract total liabilities from total assets, and the second is to add the company’s share capital (both equity and preference) as well as reserves and surplus.read more, thus increasing its creditworthiness and improving its leverage compared to its peers.

#3 – Debentures

Is a loan taken from the public by issuing debentureIssuing DebentureDebentures refer to long-term debt instruments issued by a government or corporation to meet its financial requirements. In return, investors are compensated with an interest income for being a creditor to the issuer.read more certificates under the company’s common seal? Debentures can be placed via public or private placement. Suppose a company wants to raise money via NCD from the general public. In that case, it takes the debt IPO route where all the public subscribing to it gets allotted certificates and are the company’s creditors. If a company wants to raise money privately, it may approach the major debt investors in the market and borrow from them at higher interest rates.

They are entitled to a fixed interest payment per the agreed-upon terms mentioned in the term sheetTerm SheetA term sheet is an agreement facilitating a fundraising process whereby two parties mutually agree to abide by the mentioned clauses concerning the investment.read more.They do not carry voting rights and are secured against the company’s assets.In case of any default in debenture interest payment, the debenture holders can sell the company’s assets and recover their dues.They can be redeemable, irredeemable, convertible, and non-convertible.

#4 – Term Loans

Banks or financial institutions generally give them for more than one year. They have mostly secured loans offered by banks against strong collaterals provided by the company in the form of land and building, machinery, and other fixed assets.

They are a flexible source of finance provided by the banks to meet the long-term capital needs of the organization.They carry a fixed interest rate and give the borrower the flexibility to structure the repayment schedule over the tenure of the loan based on the company’s cash flows.It is faster than the company’s equity or preference shares issue as there are fewer regulations to abide by and less complexity.

#5 – Retained Earnings

These are the profits the company has kept aside over time to meet the company’s future capital needs.

These are the company’s free reserves, which carry nil cost and are available free of charge without any interest repayment burden.One can safely use it for business expansion and growth without taking additional debt burden and diluting further equity in the business to an outside investor.They form part of the net worth and directly impact the equity share valuation.

Examples of Long-Term Financing Sources

Funds raised by an NBFC named NeoGrowth Credit Pvt. Ltd. via private equity routes from LeapFrog Investments amounting to ₹300 crores ($43 million).

source: economictimes.com

Source:- inshorts.com

Apple raises $6.5 billion in debt via bonds.

Source:- livemint.com

Paytm to raise funds via selling a significant controlling stake in the company to Warren Buffet for $10-$12 billion.

Source:- livemint.com

Advantages of Long-Term Financing

Align specifically to the long-term capital objectives of the companyEffectively manages the asset-liability position of the organizationProvides long-term support to the investor and the company for building synergiesOpportunity for equity investorsEquity InvestorsAn equity investor is that person or entity who contributes a certain sum to public or private companies for a specific period to obtain financial gains in the form of capital appreciation, dividend payouts, stock value appraisal, etc.read more to take controlling ownership in the companyFlexible repayment mechanismDebt diversificationGrowth and expansion

Limitations of Long-Term Financing

The regulators lay down strict regulations for the repayment of interest and principal amounts.High gearing on the company may affect the valuations and future fundraising.High gearing on the company may affect the valuations and future fundraising.Stringent provisions under the IBC Code for non-repayment of the debt obligations may lead to bankruptcyBankruptcyBankruptcy refers to the legal procedure of declaring an individual or a business as bankrupt.read more.Monitoring the financial covenantsCovenantsCovenant refers to the borrower’s promise to the lender, quoted on a formal debt agreement stating the former’s obligations and limitations. It is a standard clause of the bond contracts and loan agreements.read more in the term sheet is very difficult.

Important Points to Note

The company’s management needs to be assured about creating a mix of short-term and long-term financing sources. More long-term funds may not benefit the company as it affects the ALM position significantly.The company’s credit rating also plays a major role in raising funds via long-term or short-term means. Hence, improving the company’s credit rating might help the organizations raise long-term funds at a much cheaper rate.