What is Long-Term Financing?
The term “long-term financing” refers to financing instruments raised for a term of more than a year. This financing occurs through the issuance of equity shares, debt funding, long-term leases, or bonds. Typically, it is used for funding big projects, such as mergers & acquisitions, capacity expansion, etc. The basic principle is to match the future cash flow or benefits expected from the associated outlay.
Characteristics of Long-Term Financing
There are many characteristics specific to long-term financing. Some of the significant ones are as mentioned below.
- It is mostly used for supporting long-term ventures, such as mergers & acquisitions, expansion of production facilities, funding share repurchases, etc.
- The tenor for long-term financing usually falls in the range of 5 to 25 years. Such longer maturities are ideal for businesses seeking to refinance their obligations beyond the usual bank tenor.
- In the case of long-term financing, the cost of capital is usually fixed in nature, which helps mitigate the financial risks associated with interest rate volatilities.
- The typical long-term financing providers include institutional investors with a large capital base and the capacity to extend funds for longer.
Examples of Long-Term Financing
The following are some of the most common examples:
A bond is a certificate of long-term debt obligation usually issued by corporates and governments. The bond issuer has to pay the investor a fixed amount of money in exchange for the financing, called interest or coupon rate. The interest payment is made regularly at a pre-decided fixed interval of time, typically six months. The issuer also has to pay back the principal amount (also known as par value) to the bondholder at the end of the maturity period. Bonds are typically issued in the multiple of $ 1,000 and have maturity periods of 10 to 30 years. This financial instrument can be secured or unsecured, with special provisions of convertibility to equity stock or early retirement.
A mortgage loan is long-term funding made against collateral, a real estate property in this case. If the borrower fails to meet the repayment obligations, the lender has the right to seize and sell the property to pay off the outstanding loan amount. Mortgage loans are often used to finance office apartments, warehouses, and factories.
Need of Long Term Financing
An organization usually benefits when it develops a long-term relationship with the same set of investors over some time. A company can gain much more than the ongoing financial support from long-term financing and partnership if it can find the right investors. Without long-term investors, a company may have to repeatedly search for new investors who may not understand the business well. This is why it is needed for a business to flourish and perform in the long run.
Long-term financing means the borrower needs to pay back the investors or lenders over a longer period. It is usually helpful for companies in the growth phase as it allows them to invest in projects that can make great cash-generating sources shortly. In other words, it provides the required financial leverage that the borrowing company can use to generate enough cash flows to cover the cost of capital. However, too much leverage (in the case of debt funding) can invite more trouble for the borrowing company and its shareholders.
Some of the major benefits are as follows:
- It helps in aligning the company’s funding requirements to its long-term objectives.
- It enables better management of the asset-liability position of the company.
- It helps the company and the investors develop synergy through long-term association.
- In the case of long-term financing through the equity route, the investors get the opportunity to take controlling ownership of the company.
- It is especially useful for companies seeking growth and expansion.
Limitations of Long Term Financing
Some of the major limitations are as follows:
- In the case of debt funding, the repayment of interest and principal are controlled through strict regulations laid down by the regulators.
- Long-term financing to refinance obligations may conceal structural issues with a company’s cash flow.
- It may become difficult to monitor the financial covenants mentioned in the term sheet.
Some of the key takeaways of the article are:
- It refers to funding raised for more than a year that usually falls in the range of 5 to 25 years.
- This type of financing can be the issuance of equity shares, debt funding, long-term leases, or bonds.
- The providers are usually institutional investors with a large capital base and longer investment horizons.
- It is usually used for funding big projects, such as mergers & acquisitions, capacity expansion, etc.
So, it can be seen that it is an important corporate funding tool. It is best suited for companies seeking investments for funding future growth and expansion. It can be used for both external and internal strategic investments.
This is a guide to Long Term Financing. Here we also discuss the definitions, characteristics, examples, needs, and importance, along with benefits and limitations. You may also have a look at the following articles to learn more –