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SOURCES OF LONG TERM FINANCE

Presented by:Anu Damodaran

MBA G – Semester 2AUD0260

Amity University, Dubai

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Finance is life blood of business

Sources of finance1. Short term2. Long term

Finance

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Basics

Long term finance - Funding obtained for a time frame exceeding three years in duration.

Medium term finance – One to three years.

Short term finance – Less than one year.

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To finance fixed/permanent/long term assets(for income generation by operation, held for more than a year)

To finance permanent/fixed working capital (consistent and uninterrupted year to year)

- regular - reserve To finance growth and expansion of a business

Why LTF?

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LTF – fixed interest rate – period is long – less risky

STF – interest can increase and increase – more risky

(opposite for the investor)

LTF vs. STF

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Specifics

Factors determining long-term financial requirements 1. Nature and size of Business2. Nature of goods produced3. Technology used

Factors which determine obtaining the LTF

4. Creditworthiness5. Forecasting of high returns6. Investor’s risk proneness

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Imp – Type of LTF varies from business to business (partnership/proprietorship)

LTF – debt and or equity In obtaining LTF – comply to legal, technical and statutory requirements prescribed by companies act, SEBI, stock exchange authorities, laws of income tax, foreign exchange management act, banking regulations act etc.

Specifics

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Life Cycle of a firm

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Internal sources

External sources

Sources of LTF

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Venture capital/ Equity financing (external) Seed money (internal or external) - Angel investors ( internal/external) - Borrow from family, friends, acquaintances, owner (Quasi capital - internal) – loans and advances - Crowd funding (external) Reserves and surplus (internal) – from profits – in P&L – surplus and what is kept aside is general reserve

Sources of LTF*

* Common Terms

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Reserves and surplus (internal) – from profits – in P&L – surplus and what is kept aside is general reserve.*

Retained earnings (profit from operations) - internal

Depreciation (Depreciation is the expiry of service potential or consumption of operating capacity ) - internal

Sources of LTF

*The premium received when shares are issued at a premium to the face value is shown under the head reserves and surplus

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Share capital (external) - Total - Equity (owners) – voting rights - Preference (1st preference for dividends, partial ownership, no voting rights, claim on assets) – 4 different types

Sources of LTF

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IPO(stock market) – small companies for capital, large companies – publicly traded – through sponsor

Bought out deal - often associated with an Initial Public Offering - when an underwriter, such as an investment bank - purchases securities from an issuer before a preliminary prospectus is filed - at a discount

Sources of LTF

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Long term Bank loans (external) – maturity of 3 to 10 years – supported by collateral*– contract contains restrictive covenants*

Long term loans from other non banking financial institutions (external)

Secured and unsecured( bank OD)- short term, very costly, repay when bank wants

Form of debt instrument

• Pledged* Terms

Sources of LTF

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Debt - issuance of bonds to raise money (external)

Bond – debt security* -secured Debentures - unsecured

*negotiable financial instrument that represents some type of financial value – debt or equity

Sources of LTF

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Euro issue – raising funds outside India in foreign currency – bank certificates – shares of foreign companies (external) – similar to Global depository issues - convertible

Rights issue – at discount price – additional shares by shareholders – transferable i.e. can sell in open market

Sources of LTF

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Advantages and Disadvantages

Advantages

Less prone to short term shocks as it is secured by formally established contractual terms. They are relatively more stable.

Well structured and defined. Thus fewer resources have to be channeled to monitor and maintain long-term debt financing accounts.

Financing options such as leases offer a certain degree of flexibility, compared to having to purchase the asset (E.g. machinery).

Disadvantages

Costly to service (interest charges are higher).

Long term debt financiers demand information from the company to perform its credit evaluation.

Start-ups usually find it more difficult to obtain long term debt financing, or if they do, at unfavorable terms, as they have almost no proven track record, low cash flow, and small asset base.

Contracts normally contain a lot of restrictive clauses and covenants, including the scope of business operations that the company is allowed to engage in, capital and management structure limitations, etc.

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Considering the often large amounts of funds involved, long term debt financing is a relatively risky source of financing.

Breach of debt covenants may result in the company going into financial distress. For example, certain clauses state that if a certain covenant is breached, the entire loan amount has to be repaid in full immediately, or the mortgaged asset confiscated.

Risks

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Good and efficient financial management is to raise the funds whenever required and at the most competitive terms and conditions

THANK YOU!!!!!!!!!!

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