Long term finance can be defined as the funding obtained for a time frame which Is exceeding 12 months In duration. It usually has a term of at least 12 months up to 25 years. Long term finance can be seen when a business uses long term finance method to borrow funds from the bank and it has to pay back the loan over more than 12 months period. Merchant back offers long term finance generally. Long term finance is used for investments and projects that have an indefinite or long term date such as more than 12 months.
Why the long term finance Is being used widely nowadays? Reason for usage of long term finance Includes expansion Into new markets, purchases of assets such as machinery, land and buildings and business growth through the acquisition of other business of There are many types of long term finance. The first type is the properties. Shares. What is share? Basically, a share is a part ownership of a company or a firm. Companies that set up as private limited companies or public limited companies are related to shares. There are many small firms who decide to set themselves up as private Limited companies.
To expand business, more shares should be Issued. However, there are limitations on who they can sell shares to. For example, any share issue has to have the full backing of the existing shareholders. Private limited companies are different. Why they are different? This is because they sell shares to the general public. What does this means? It means anyone can buy the shares in the business. Some firms started out as a private limited company. As time passes by, they have expanded throughout the time. Then they will come to a period where they cannot even Issue any more shares to their friends and family.
To keep on expanding, hey will eventually need more funds to do so. This will slowly lead them to becoming a public limited company. When this occurs, we called it as ‘floating the businesses. To enable to offer shares to the public, the business will need go through a number of administrative and several legal procedures. Shares can be also divided Into two types. The first type will be the equity shares. By Issuing ordinary equity shares, public limited companies will raise funds from promoters or from the investing public by way of owner’s capital or equity capital.
Equity share is a foundation of permanent capital. Equity shareholders r ordinary shareholders are the holders of such share capital in the company. Owners of company are practically the equity shareholders as they take on the highest risk. Equity shareholders are entitled to dividends after the income claims of other stakeholders are satisfied. Ordinary shareholders can Implement their claims of assets after the claims of the other suppliers of capital have been met. Ordinary shares are usually having the highest cost.
This is due to the fact that such shareholders expect a higher rate of return on their investments as compared to other suppliers of long term funds. Security to other suppliers of funds is also revived by the ordinary share capital. Any organization giving loan to a company must make sure that the debt-equity ratio Is comfortable to cover the debt. Would be that the company has no liability for cash outflows associated with its redemption. Besides, company’s financial base will increase and this will eventually help to strengthen the borrowing powers of the company.
Not only that, by making a right issue, the company will be able to make further issue of share capital. There are also some negative effects of raising funds by issue of equity shares. The first negative effects would be the cost. Cost of ordinary shares will be higher due to the dividends which are not tax deductible. Besides, investors will find shares riskier due to the high cost of ordinary shares. This is because of the indecisive dividend payments and capital gains. Lastly, it will greatly trim down the ownership and existing shareholders can be controlled.
The second type of shares will be the preference share capital. It can describe as a unique type of share. Why is it unique? The holders of such shares will benefit from priority, both as regards to the payment of a fixed amount of dividend and repayment of capital on winding up of the company. Besides, a public issue of shares can help to raise the preference share capital. Not only are that, rate of dividend on preference shares are normally higher than the rate of interest on debentures and loans. Most of preference share nowadays carry a specified of period.
At the end of a specified period, the funds have to be repaid. Preference share capital may be redeemed at a pre decided future date or at an earlier stage inter alai out the profits of the company. This will allow promoters to withdraw their capital from the company which is now self-sufficient capital and may be reinvested in other profitable ventures. There are several benefits of raising funds by issue of preference shares. The first would be that the nonpayment of preference dividends. Preference share does not force company into liquidity.
Besides, there is no risk of takeovers. Moreover, they provide fixed and pre decided preference dividends. Lastly, after a specified period, preference capital can be redeemed. There are also several impacts of the preference shares. The first impacts are that preference dividend is not tax deductible. Therefore, a tax shield is provided to the company. This will lead to preference share to be more costly to the many than debt. Lastly, preference dividends are cumulative in nature. This means that although these dividends may be omitted, they shall need to be paid later.
No dividend can be paid to ordinary shareholders if these dividends are not paid. The second type of long term finance will be the debentures. Debentures can be also referred as bonds. Loans can be raised from public. Debentures are usually issued in various denominations and they carry various rates of interest. Debentures are also issued on the basis of a debenture trust deed which lists the terms and conditions on which the debentures are floated. Besides, debentures are said to be either unsecured or secured.
Debentures are actually a gadget or tool for increasing long term debt capital. There are several advantages of raising finance by issue of debentures. The first would be that the cost. Cost of debentures is much lower compared to the cost of preference or equity capital . Cost of preference or equity capital has the interest which is actually a tax deductible. Besides, dilution of control will not be resulted from debenture financing. There are also few disadvantages of debentures. The first disadvantages would be that debentures interest and capital repayment are compulsory payments.
Besides, the protective debentures will also improve the financial risk associated with the firm. Lastly, debentures have to be paid during the end of development. This will lead to a huge amount of cash outflow needed at that time. The third type of long term financing will be the venture capital financing. What is venture capital financing? Venture capital financing refers to the financing of new high risky venture. It is promoted by qualified entrepreneurs who lack of experience and funds. This is to give shape to their ideas.
Venture capital financing will make investment to buy equity or debt securities from inexperienced entrepreneurs who undertake highly risky ventures with a potential success. Basically, venture capital financing is equity finance in new born companies. It can be viewed as a long term investment in growth. The last type of long term financing will be the mortgage. What is mortgage? Mortgage is a loan specifically for the purchase of property such as cars and houses. Some businesses might purchase property through a mortgage. Mortgages are usually used as a security for a loan in most cases. This often happen to the small businesses.