Long Term Financing

Long Term Financing Definition

Long term financing means financing by loan or borrowing for a term of more than one year by way of issuing equity shares, by the form of debt financing, by long term loans, leases or bonds and it is done for usually big projects financing and expansion of company and such long term financing is generally of high amount.

Long Term Financing

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Source: Long Term Financing (wallstreetmojo.com)

Sources of Long Term Financing

#1 – Equity Capital

IPO

It represents the interest-free perpetual capital of the company raised by public or private routes. Either the company may raise funds from the market via IPOIPOInitial Public Offering (IPO) is when the shares of the private companies are listed for the first time in the stock exchange for public trading and investment. This allows a private company to raise the capital for different purposes.read more or may opt for a private investor to take a substantial amount of stake in the company.

#2 – Preference Capital

perpetual-preferred-stock

Preference shareholders are those who carry preferential rights over equity shareholders in terms of receiving dividends at a fixed rate and getting back invested capitalInvested 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 in case if the same is wound up.

  • It is a part of the Net Worth of the Company thus increasing the creditworthiness and improving the leverage as compared to the peers.

#3 – Debentures

External sources of finance - Debenture Financing 1

Is a loan taken from the public by issuing debenture certificates under the common seal of the company? debentures can be placed via public or private placement. If a company wants to raise money via NCD from the general public, it takes the debt IPO route where all the public subscribing to it gets allotted certificates and are creditors of the company. 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 payment of interest as per the agreed-upon terms mentioned In the term sheet.
  • They do not carry voting rights and are secured against the assets of the company.
  • In case of any default in payment of debenture interest, the debenture holders can sell the assets of the company and recover their dues.
  • They can be redeemable, irredeemable, convertible, and non-convertible.

#4 – Term Loans

Long Term Financing

They are given generally by banks or financial institutions for more than one year. They have mostly secured loans given by banks against strong collaterals provided by the company in the form of land & bldg, 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 rate of interest and gives the borrower the flexibility to structure the repayment schedule over the tenure of the loan based upon the cash flows of the company.
  • It is faster as compared to the issue of equity or preference shares in the company as there are fewer regulations to abide and less complexity.

#5 – Retained Earnings

Retained Earnings - Colgate 3

These are the profits that are been kept aside by the company over a period of time to meet the future capital needs of the company.

  • These are free reserves of the company which carry nil cost and are available free of cost without any interest repayment burden.
  • It can be safely used 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 have an impact directly on the equity share valuation.

Examples of Long Term Financing Sources

1) Funds raised by an NBFC named Neo Growth Credit Private Limited via private equity routes from LeapFrog Investments amounting to Rs 300 Crores (~43 Million Dollars)

Long Term example 1

source: economictimes.com

2) Amazon raised $54million via IPO route to meet the long term funding needs of the company in 1997.

Amazon example 2

Source:- inshorts.com

3) Apple raises $6.5 billion in debt via bonds

Apple example 3

Source:- livemint.com

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

Livemint example 4

Source:-  livemint.com

Advantages of Long Term Financing

Limitations of Long Term Financing

Important Points to Note

  • The management of the company needs to be assured about creating a mix in the short term and long term financing sources of the organization as more long term funds may not be beneficial for the company as it affects the ALM position significantly.
  • The credit rating of the company also plays a major role in raising funds via a long term or short term means. hence improving the credit rating of the company might help the organizations to raise the long term funds at a much cheaper rate.

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