As opposed to short-term financing, long-term financing is classed as borrowing for more than 12 months. The typical repayment period can be from 5 to 20 years.
Long-term finance can be useful to meet a company’s investment goals and long-term business plan. As such, finance to fund investment in fixed assets, land, buildings, machinery are all consider prudent uses for long-term financing.
What is long-term finance?
Long-term finance is raising funds through debt or equity financing for a term of over 1 year. It is common for the amounts to be large, so usually takes time to agree with your lender, or to raise the funds from investors.
Debt finance is usually provided by a bank or other financial institution in some form borrowing – with the capital to be repaid on a future date or through regular repayments.
Equity finance is when a share or stake in the business is exchanged (sold) for investment in the business.
Therefore, the use of long-term finance is mainly for strategic projects and developing the business capabilities for a number of years to come.
Check out if long-term or short-term finance is right for you by completing this quick form here.
Long-term financing sources
So which form of financing will be right for your business needs? Let’s explore some of the common sources of finance, and their pros and cons.
Examples of sources for long-term finance include:
- long-term bank loans
- Share capital
- Preference shares
- Venture capital
The majority of long-term finance is provided by commercial banks. For SMEs, equity finance is usually limited to raising money via friends and family or local investors. Both of these sources can be time consuming, and are certainly not guaranteed to raise the funds required.
Loan capital/long-term bank loans
The traditional route was to go to your bank and ask for a loan. Depending on your business circumstances, this could be a secured (eg on property) or unsecured loan. There will be interest to pay on the loan, and they often has a fixed repayment terms, allowing you to budget.
Most companies are able to borrow from the bank if you have the appropriate security. Although smaller firms are often charged a higher interest rate, and are less likely to be able to obtain an unsecured loan. Any loan on the business will also adversely affect your gearing ratio, putting the company at greater financial risk.
When you start a company, the money you put into it translates into shares – i.e. the owner of the company is who holds the company shares.
If you utilise equity finance for your business, you are essentially selling the ownership to whomever buys the shares. In the case of a limited company, this might be more investment from yourself and your business partners. However, if you choose to attract investment from friends, other family members or venture capitalists, then you are diluting your ownership. Therefore, the consequence is that others have voting rights, share in the company profits and have a claim over any company assets.
The advantage is that the cash injection to your business does not need to be repaid.
Further issuing of shares will dilute the control of the original business founders.
Another source of long-term finance are preference shares. As the name implies, they carry more weight than ordinary shares. A preference share holder will always be paid first from company profits – often at a fixed dividend. The remaining profits are then paid to ordinary shareholders.
The company also has the option of issuing redeemable preference shares. This type can be bought back by the company.
One major source of long-term finance are debentures. This popular form of debt capital can be issued by private companies. They are effectively a type of loan, as the company pays the debenture holder a fixed amount of interest over the agreed term.
Types of debentures can include redeemable or irredeemable, convertible (fully or partly), non-convertible and secured.
In many cases we might recommend invoice factoring or discounting, but can advise you on MCA, ABL and other solutions too.
Talk to us today to explore the best options for your business.
Advantages of long-term financing
Each form of financing is a balance of the risk shared between the business owner and the finance company. If the risk is mainly with the lender, then the rate of interest is likely to be higher, whereas if the majority of the risk is with the borrower, the repayments will be more favourable.
One advantage to the business owner utilising long-term financing is that the risk shifts to the finance company. So, although this means the capital cost can be higher than short-term financing options, the risk is lower.
Other advantages of long-term financing include:
- Linked to strategic business plan and objectives.
- Ability to plan and grow the future of the business.
- Flexible and structured repayment options.
- Opportunity to bring in investors who will help build the business.
Disadvantages of long-term financing
- Strict interest and repayment terms.
- Impact of higher gearing for the company exposes the company to future risk and also may affect future credit.
- Higher cost of capital than some short-term options.
Long-term financing examples
Examples of long-term financing include issuing shares or equity, debentures or business loans. Short-term financing includes overdrafts, lines of credit or invoice finance.
Long-term finance should generally be used for investment in line with the company’s strategic business goals. Short-term for cashflow issues or to invest quickly to meet new opportunities.
So, which should you go for, short- or long-term financing?
How do you decide? Is one better than the other?
|Short-term financing||Long-term financing|
|Typically under 12 months||5 – 20 years|
|Variable rates||Fixed rate|
|Specialist lenders and banks||Banks or investors|
|Use for cashflow and short-term needs or opportunities||Use for long-term investment strategies|
When you issue an invoice, you do not receive the funds immediately. Often 30, 60 or 90 days later. During this period of time, your business may need to cover this temporary deficit with other cashflow. Short-term finance such as invoice factoring or invoice discounting is used here because it is relatively easy to arrange, and access to the money is fast.
Alternatively, if are investing in new equipment or a new office, you should consider long-term finance. The pay back for your investment will take longer, therefore long-term financing is more appropriate.
Short-term financing sources such as invoice factoring or discounting can provide quick injections of cash to help cashflow and fund investment for relatively low risk and cost.