LONG TERM FINANCE
Prepared by
Dr. Santosh Solanki
LNCT-MBA
Long Term Sources of Finance
Meaning:-
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. Long term financing is
required for modernization, expansion,
diversification and development of
business operations.
Sources Of Long Term Finance
qEquity Shares Preference Shares
q Retained earnings
qDebentures or bonds
qLoans form banks and financial
institutions
q Venture capital financing
qLease financing
Equity shares
ØWhich are not preference shares
ØAlso called ordinary shares and
holders are real owners of the
company.
Ø“A share is a share in the share capital
of the co.”
ØIt can be issued at discount, premium
or at face value.
Features
No claim on income
No claim on assets
Right to control Voting right
Pre-emptive right
Limited liability
Transfer of shares
Advantages
Source of fixed capital
No obligation for repayment
No charge on assets
Small nominal value such as Rs.10
Ideal for adventurous investors
Voting power
Right to new shares
Disadvantages
High risk
Due to pre-emptive right
management of the co. may be
concentrated in few hands
No trading on equity
Preference Shares
§ Enjoys preferential rights over
equity shares in - payment of
dividend and - repayment of capital
§ Considered as hybrid security
Features
Senior security compared to equity
shares
Dividend is not tax deductible
Fixed return
No voting right
No charge on assets
Flexible – redeemable and irredeemable
Sinking fund provision can be used
Types
§ Cumulative and non cumulative
§ Participating and non participating
§ Redeemable and irredeemable
§ Convertible and non convertible
Advantages
Appeal to cautious investors – who
seek reasonable safety and return
No obligation for dividend
No interference in management
No charge on assets
Flexibility
Variety
Disadvantages
Fixed obligation
Limited appeal – not attractive to
those who wants higher return
Low return
No voting rights
Debentures
§ A debenture is a certificate or
document issued by a company under
its seal as an acknowledgement of
debt.
§ Repayment is at winding up or
maturity.
§ Reward is known as interest at fixed
rate.
Features
vDebentures represents borrowed capital
vInterest on debentures is payable on a fixed
rate
vInterest on debentures is an obligation to the
co.
vDebenture holders are creditors to the
company
vDebenture holders have no voting rights
vDebentures may involve a charge on assets of
the co.
vflexibility
Types of Debentures
vNaked or simple and secured or
mortgaged
vRedeemable and irredeemable
vConvertible and non convertible
vRegistered and bearer debentures
vFirst and second debentures
Advantages
No voting rights
Fixed interest
Debenture interest is an expense to
the co.
Can be redeemed
Trading on equity is possible
Disadvantages
Interest is an obligation to the
company
Creates a charge on company’s
assets
Common people can not buy
debentures as they are of high
denominations
Shares v/s debentures
Shares Debentures
§ part of owned capital § part of borrowed capital
§ return is dividend § return is interest
§ variable rate of retrn § fixed rate of return
§ voting rights, owners § no voting rights,
and control over mgt. creditors and no control
§ can not redeem over mgt.
§ no priority at winding § can redeem
up § priority over equity
shares
Venture capital
It is often used for growth and expansion
of new and young enterprises.
Generally considered as high risky capital
Venture capitalist will involve in the
management of the enterprise.
They generally support to proven
technologies.
Features
Equity participation
Long term investment
Participation in management
Process of venture financing
1) Deal origination – it is an active search for
financiers
2) Screening – initial evaluation of all available
venture capitalist
3) Risk analysis
4) Deal structuring – if both the parties are
satisfied they negotiate the terms of
investment
5) Post investment activities – venture
capitalist can act as an owner
Conditions of venture capital
According to Govt. of India :-
1. Total investment should not
exceed Rs.100 millions
2. New companies which incorporate
some significant improvement
over the existing one’s in India
3. Should have qualified professionals
Term Loan
qA term loan is granted on the basis of a
formal agreement between the
borrower and the lending institution on
the basis of an asset as a security for a
fixed period of time.
qIn india commercial banks and
specialized financial institutions like
IDBI, ICICI, IFC, etc are providing term
loans.
Conditions of term loan lending
ØAn asset as a security
ØMinimum working capital
ØThere will not be any additional
debt
ØManagement should be effective
Lease financing
§ A lease is a contract between a lessor ie
owner of the asset and the lessee, the
user of the asset.
§ Owner gives the right to use the asset
over an agreed period of time for a
consideration called lease rental.
§ Lessor is the legal owner and he can
claim the depreciation.
Advantages of lease financing
[Link] provides 100% financing:-
Lessee can avoid the payment for acquiring asset
and even if he has no sufficient fund he can acquire
asset by paying lease rental. He can use the fund for
some other purposes.
2. Leasing improves performance:-
vLessee has to pay lease rental for the asset which did
not appeared in the balance sheet. Naturally the
performance of the lessee will be improved.
Contd…..
3. Leasing avoid cost of screening:-
For a long term investment screening of all
alternatives is an unavoidable part. But in leasing it is
the duty of the lessor and therefore there is no such
cost.
4. Convenience and flexibility:-
It is very cenvenient for lessee because lessor
will undertake all the requirements of the
asset.
Limitations of leasing
[Link] option:-
Leasing company is a financial intermediary
and he will charge heavy interest for lease
financing.
2. Loss of tax:-
Lessee can not claim depreciation in leasing
because he is not the actual owner.
Contd….
3. No ownership:-
Leasing does not provide the advantages
of ownership to the user.
4. Loss of residual value:-
The leased asset has to be returned to
the lessor at the end of the lease period.
THANKS
