In an organized sector, there are five specific sources of financing to meet the long-term requirements of a firm: These are discussed in the following paragraphs: Equity shares were earlier known as ordinary shares (or common stock). Allow debenture holders to receive payment before equity and preference shareholders even at the time of liquidation of an organization. It represents the interest-free perpetual capital of the company raised by public or private routes. 4 Sources of Long Term Financing 4.1 External sources of finance 4.2 Equity Shares 4.3 Preference Shares 4.4 Debentures and Bonds 4.5 Venture capital 4.6 Term Loans 4.7 Lease financing 5 Internal Sources of finance 5.1 Retained earnings 5.1.1 Advantages of Retained Earnings 5.2 Sale of assets Long Term Financing Needs of a Business This led to the deregulation and liberalization of the Indian economy and also increased the flow of foreign capital into the country. iii. Characterize by fluctuations in returns, iii. At the same time, shareholders may get back money from the sale of shares in the stock exchanges. Sources of Long Term Finance Definition: The Sources of Long Term Finance are those sources from where the funds are raised for a longer period of time, usually more than a year. In addition, long-term financing is required to finance long-term investment projects. In simple terms, it means giving the asset on hire or rent. In those sources, they are mainly divided in two groups, which are short-term sources of finance and long-term sources of finance. But, in India no such distinction is made between bonds and debentures and the two terms are used as synonymous. In case of higher profits too, the company is not legally bound to distribute dividends. Term Loans 8. The warrant gives a right to the debenture holder to obtain equity shares specified in the warrant after the expiry of a certain period at a price not exceeding the cap price specified in the warrant. (f) The less debt the company has, the more attractive it is to potential investors and buyers. Tax liability on dividends differs in different zones, states, and countries. (vi) Hindrance in the Free Flow of Capital According to Prof. Pigou, Excessive ploughing back entails social waste, because money is not made available to those who can use it to the best advantage of the community, but is retained by those who have earned it.. Each type of shares has a different set of characteristics, advantages, and disadvantages. Term loans are the types of long-term loans that are raised for the duration of 3 to 10 years from financial institutions. Involve less cost in raising funds than equity shares, ii. A term sheet is an agreement facilitating a fundraising process whereby two parties mutually agree to abide by the mentioned clauses concerning the investment. The characteristics of term loans are as follows: i. (d) Sometimes internal accruals as a source of finance are preferred over the other sources due to the financial and taxation position of the companys shareholders. Lease financing, therefore, does not affect the debt raising capacity of the enterprise. Report a Violation 11. They are a flexible source of finance provided by the banks to meet the long-term capital needs of the organization. Most of the new instruments are simply old conventional instruments with some added features. There is a lock-in period for SPN during which no interest will be paid for an invested amount. (iv) Ownership Dilution If the new shares are issued to the public, it may dilute the ownership and control of the existing shareholders. Features of Long-term Sources of Finance -. Term loans, also referred to as term finance, represent a source of debt finance, which is generally repayable in less than 10 years. Financial Institutions may also restrict the payment of dividend, salaries and perks of managerial staff. Image Guidelines 4. Maturity refers to the last day of paying the financier the real amount of finance. (e) Secured Premium Notes (SPN) with Detachable Warrants: SPN which is issued along with a detachable warrant, is redeemable after a notice period, say four to seven years. and is accumulated from the capital market. The fundamental principle of long-term finances is to finance the strategic capital projects of the company or to expand the companys business operations. Financial Institutions are another important source of long-term finance. For example, if an expansion or acquisition is allowed with venture capital, the investor might demand part ownership of the firm, rather than simply a share in the profits, including a say in management. The advantages of term loans are as follows: ii. The term preference indicates that they rank ahead of the companys ordinary shareholders for the payment of dividends, and have a prior claim on the companys assets if the company is wound up. In most developing countries like India, domestic capital is inadequate for the purpose of economic growth. Issue of debentures. Here, we discuss the top 5 sources of long-term financing, examples, advantages, and disadvantages. (v) Convertibility Financial institutions usually insist on the option of converting their loans into equity shares of the company. This can include real estate, patents, works of art, and other assets controlled by the company. You are free to use this image on your 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). Irredeemable Debentures Refer to the debentures that are not paid back during the lifetime of an organization. Allow an organization to raise secured loans. These are also known as preferred stock or preferred shares. (iv) No Need to Mortgage the Assets The company need not mortgage its assets to secure equity capital. (vii) No Effect on Debt-Equity Ratio Lease is considered a hidden form of debt because neither the leased asset nor the lease liability is depicted on the balance sheet. However, term loan providers are considered as the creditors of the organization. Hence, raising finance via debt is a desirable and prominent source of finance. These low-coupon bonds are issued with call or put provisions. Owner of the asset is called Lessor and the user is called Lessee. The dividend policy of the company is determined by the directors. Whatever may be the outcome of such controversy, the fact remains that the depreciation is a sum that is set apart out of profits and retained within the business. Whenever an organization has accumulated surplus profit, it may distribute the profit among its existing shareholders by providing them bonus shares. (iii) Not Bound to Pay Dividend A company is not legally bound to pay dividend to its equity shareholders. Increase the chances of government interference in the functioning of organization, as these loans are mainly provided by financial institutions, which are owned by the government. It may come from different sources such as equity, debt, hybrid instruments, or internally generated retained earnings. Sources of Long-Term Finance for a Company, Firm or Business But in case of Companies whose financial . The amount of long term capital depends upon the scale of business and nature of business. (b) If the purpose for utilization of retained earnings is not clearly stated, it may lead to careless spending of funds. In other words, a debenture is an agreement between a debenture holder and an organization, which acknowledges that the organization would repay the debt at a specified date to debenture holders. A debenture is a certificate issued by a company under its seal acknowledging a debt due by it to its holders. In USA there is a distinction between debentures and bonds. Medium term finance One to three years. Equity Shares 2. Long-term finance generally helps businesses in achieving their long-term strategic goals. After the maturity of the financed the borrower needs to return the financier the real amount with some profit and interest. Lease Financing 7. Internal Sources 10. The money raised from the market does not have to be repaid, unlike debt financing which has a definite repayment schedule. Trade Credit Depending on various factors, the period can stretch for more than 5 to 20 years. It is also referred to as ploughing back of profit. v. Redeemable Debentures Refer to the debentures that are paid back during the existence of an organization. SBA 7 (a) loans, for example, range from $25,000 . In addition, long-term financing is required to finance long-term investment projects. Term Loans 8. At the time of liquidation, these shares are paid after paying all the liabilities. vi. In India, the two terms, bonds and debentures are used interchangeably. By using our website, you agree to our use of cookies (. Ploughing back of profits is made by transferring a part of after tax profits to various reserves such as General Reserve, Reserve Fund, Replacement Fund, Dividend Equalisation Fund etc. Let us start the discussion with the equity shares. You can learn more about excel modeling from the following articles: . They have control over the working of the company. The warrant is a traceable negotiable instrument and is listed on stock exchanges. Paying dividend on equity shares is not an obligation for an organization when there is less profit or loss, ii. (v) Not Entitled to Tax-Benefits Lessee is not entitled to certain tax benefits like depreciation and investment allowance because he is not the owner of the asset. An additional disadvantage from borrowers viewpoint is that the loan contracts contain certain restrictive covenants which restrict the managerial freedom. (b) Like other sources of debt financing, the lenders of term loans do not have any right to have direct control over the affairs of the company. Issuing bonus shares is beneficial for both the organization as well as the shareholders. (iii) Free from Restrictive Covenants Lease financing is free from restrictive covenants whereas the financial institutions often put a number of restrictions on borrowers, such as, conversion of loan into equity, appoint nominee directors, restrictions on payment of dividend, and so on. iv. Before uploading and sharing your knowledge on this site, please read the following pages: 1. In the name of ploughing back of profits, they may declare lower dividends and when the share values fall in the market, they may purchase them at reduced prices. They are entitled to dividends after paying the preference dividends. These shares do not carry any preferential or special rights in respect of annual dividends and in the repayment of capital at the time of liquidation of the company. From their standpoint, retained earnings are an attractive source of finance because investment projects can be undertaken without involving either the shareholders or any outsiders. In case the SPN holder holds it further, the holder will be repaid the principal amount along with the additional amount of interest/premium on redemption in installments as decided by the company. Follows: i these are also known as preferred stock or preferred shares 20 years does affect! 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