At the time of liquidation, these shares are paid after paying all the liabilities. However, unlike the sole proprietor or the partner of a firm, the risk of the shareholders in case of insolvency is limited to their capital contribution. A company does not generally distribute all its earnings amongst its shareholders as dividends. When businesses need to use the money in the long term (more than five years), this creates the need for long-term finance. They do not carry voting rights and are secured against the companys assets. The characteristics of term loans are as follows: i. Do not bind an organization to offer any asset as security to preference shareholders, v. Carry less risk for investors as compared to equity shares. This makes employees feel that they are owners of the organization and motivate them to demonstrate dedication in their work. The ever growing financial requirements of the corporate sector have resulted in an intense competition between them to corner investors funds. These low-coupon bonds are issued with call or put provisions. (iv) No Need to Mortgage the Assets The company need not mortgage its assets to secure equity capital. Long-term financing is a mode of financing that is offered for more than one year. (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. Leasing is, thus, a device of long term source of finance. These covenants may be in respect of maintaining a minimum current ratio, not to create further charge on assets, not to sell fixed assets without the lenders approval, restrain on taking additional loan, reduction in debt-equity ratio by issuing additional shares etc. 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. For example, the Rs.12,000 loan may be divided by the 12 payment periods each resulting in a principal payment of Rs.1,000 per loan payment. In USA there is a distinction between debentures and bonds. Share capital or Equity shares Before uploading and sharing your knowledge on this site, please read the following pages: 1. Trade Credit Equity Share Capital: Equity shares, also known as ordinary shares or common shares represent the owners' capital in a company. These shares are treated as the base for capital formation of the organization. Non-Convertible Debentures Refer to the debentures that have no right to get converted into the equity shares during their maturity period. Funds acquired by issue of debentures represent loans taken by the company and are also known as debt capital. Limiting the liability of equity shareholders to the amount of shares they hold, iv. (iv) Ownership Dilution If the new shares are issued to the public, it may dilute the ownership and control of the existing shareholders. Depending on various factors, the period can stretch for more than 5 to 20 years. Invested Capital Formula = Total Debt (Including Capital lease) + Total Equity & Equivalent Equity Investments + Non-Operating Cash. Funds raised through these can be paid back over many years. They form part of the net worth and directly impact the equity share valuation. When companies are considering new investments, they may compare available sources of finance to determine which would be most appropriate for a new endeavor. Convertible Preference shares Refer to the shares that can be converted into equity shares after a certain time-period. A financial plan is typically considered long-term when its goals span more than a year into the future. (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. The sources of long-term finance refer to the institutions or agencies from, or through which finance for a long period can be procured. At the same time, shareholders may get back money from the sale of shares in the stock exchanges. Help in collecting funds at the right time, iv. 4) Paytm to raise funds via selling a significant controlling stake in the company to Warren Buffet for $10-$12 billion. Allow debenture holders to receive fixed rate of interest, iii. Provide low returns to preference shareholders, ii. (iii) Helpful in Following a Balanced Dividend Policy Such a company can follow the policy of paying regular and balanced dividends because it can use retained earnings for paying dividends in the years when there are inadequate profits. On the balance sheet of the company, equity share capital is listed as stockholders equity or owners equity. These units are known as share and the aggregate values of shares are known as share capital of the company. They have the right to elect the directors as well as vote in the meetings of the company. Customers' advances 4. Equity financing is the process of the sale of an ownership interest to various investors to raise funds for business objectives. This is particularly important in the case of assets where the income tax laws provide for accelerated depreciation. 3.3 Break-even analysis. ii. (ii) Over-Capitalisation Retained earnings are used for the issue of bonus shares which may result to over-capitalisation without any corresponding increase in its earnings. Besides asset security, the lender of the term loans imposes other restrictive covenants to the borrower depending upon the nature of the project and the financial condition of the borrowing company. 3.5 Profitability and liquidity ratio analysis. Long-term financing means financing by loan or borrowing for more than one year by issuing equity shares, a form of debt financing, long-term loans, leases, or bonds. iii. Hence, a group of shareholders may control the company by purchasing shares and they may use such control for their personal advantage at the cost of companys interests. Here, we discuss the top 5 sources of long-term financing, examples, advantages, and disadvantages. SOURCES OF LONG TERM FINANCE Presented by: Anu Damodaran MBA G Semester 2 AUD0260 Amity University, Dubai 1; Finance Finance is life blood of business Sources of finance 1. Serve as a source of long-term capital and are repaid during the lifetime of the organization. A debenture is a certificate issued by a company under its seal acknowledging a debt due by it to its holders. 3.6 Efficiency ratio analysis. Debentures are usually secured by a charge on the immovable properties of the company. The volatility of markets is a major factor that should be considered to determine the price of a share in the market at a particular point of time. Each type of shares has a different set of characteristics, advantages, and disadvantages. Following points explain the type of debentures in brief: i. Financial Institutions may also restrict the payment of dividend, salaries and perks of managerial staff. It is of vital significance for modern business which requires huge capital. (ii) A Cushion to Absorb the Shocks of the Business A concern with large reserves can easily absorb the shocks of trade cycles and the uncertainty of market. Long-Term Sources of Finance Long-term financing means capital requirements for a period of more than 5 years to 10, 15, 20 years or maybe more depending on other factors. (v) Right Shares Equity shareholders are entitled to get right shares whenever the company issues new shares. (iv) Excessive Penalties Sometimes, lessee has to pay excessive penalties if he terminates the lease before the expiry of lease period. Earlier all equity shares had equal voting rights. Dividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the companys equity. Debt Capital 9. Do not provide any voting rights to preference shareholders, iv. The subscription price at which the right shares are offered to them is generally much below the shares current market price. The sources from which a finance manager can raise long-term funds are discussed below: 1. Entire profits may be ploughed back for expansion and development of the company. The 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. (c) Sometimes, a conservative dividend policy leads to huge accumulation of retained earnings leading to over-capitalization. A portion of debenture can be converted into equity shares, the second portion may be redeemed after some period, and third portion may be non- convertible and continue to provide interest at the option of the holder. Prohibited Content 3. The rate of interest is high for overdrafts compared to bank loans. Providing higher dividends to equity shareholders whenever an organization makes huge profit, v. Providing voting rights to equity shareholders of an organization. An additional disadvantage from borrowers viewpoint is that the loan contracts contain certain restrictive covenants which restrict the managerial freedom. It represents the interest-free perpetual capital of the company raised by public or private routes. Rate of Return (ROR) refers to the expected return on investment (gain or loss) & it is expressed as a percentage. Such retained earnings may be utilised to fulfil the long-term, medium-term and short-term financial requirements of the firm. Capital Markets 6. It includes clauses and conditions, which are as follows: iv. (f) The burden of periodic installments in term loans brings in a discipline in the management for better management of cash flows and other operations. However, they may be rescheduled to enable corporate borrowers to tide over temporary financial exigencies. If an organization raises funds through issuing debentures, it needs to pay a fixed rate of interest at regular intervals. Preference shares give preferential rights to their holders in comparison to equity shares. These are called covenants. This got worse as Canberra began to worry . Financial Management, Company, Finance, Sources, Sources of Long-Term Finance. Huge Collection of Essays, Research Papers and Articles on Business Management shared by visitors and users like you. This method of financing is also known as self-financing or internal financing. An organization uses term loans to purchase fixed assets and fund projects having long-gestation period. The objective of charging depreciation is to spread the cost of the fixed asset over its useful life for the purpose of ascertaining the result of operations as well as accumulation of funds for replacement of asset. CFA Institute Does Not Endorse, Promote, Or Warrant The Accuracy Or Quality Of WallStreetMojo. Here we discuss the two types of external sources of finance: long-term financing (equity, debentures, term loans, preferred stocks, venture capital) and short-term financing (bank overdraft and short-term loans). Term loans differ from short-term loans which are employed to finance short-term working capital need and tend to be self-liquidating over a period of time usually less than a year. A debenture is a marketable legal contract whereby the company promises to pay, whosoever owns it, a specified rate of interest for a defined period of time and to repay the principal on the specific date of maturity. (B) Disadvantages or Dangers of Excessive Ploughing Back: (i) Misuse of Retained Earnings It is not necessary that the management may always use the retained earnings to the advantage of shareholders. But, an existing company can also generate finance through its internal sources, i.e., retained earnings or ploughing back of profits. Debentures refer to long-term debt instruments issued by a government or corporation to meet its financial requirements. At the end of lease period, the lessee is usually given an option to buy or further renew the lease contract for a definite period. The characteristics of debentures are as follows: i. This source of finance does not cost the business, as there are no interest charges applied. Hence, improving the companys credit rating might help the organizations raise long-term funds at a much cheaper rate. (i) Right to Control Equity shareholders are the real owners of the company. Bonds are generally issued by government agencies, financial institutions and large corporations, and debentures are issued by companies. They are designed to meet the long-term funds requirement of the issuer and investors who are not looking for immediate return. 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