Sources of Long-term Finance

The main sources of long term finance are as follows:

1. Shares:

These are issued to the general public. These may be of two types:
(i) Equity and (ii) Preference. The holders of shares are the owners
of the business.

Preference Shares :
Preference Shares are the shares which carry preferential rights over the equity shares.
These rights are (a) receiving dividends at a fixed rate, (b) getting back the capital in case
the company is wound-up. Investment in these shares are safe, and a preference
shareholder also gets dividend regularly.

Equity Shares:
Equity shares are shares which do not enjoy any preferential right in the matter of
payment of dividend or reppayment of capital. The equity shareholder gets dividend only
after the payment of dividends to the preference shares. There is no fixed rate of dividend
for equity shareholders. The rate of dividend depends upon the surplus profits. In case of
winding up of a company, the equity share capital is refunded only after refunding the
preference share capital. Equity shareholders have the right to take part in the
management of the company. However, equity shares also carry more risk.

2. Debentures:

These are also issued to the general public. The holders of debentures are the creditors of
the company. Whenever a company wants to borrow a large amount of fund for a long
but fixed period, it can borrow from the general public by issuing loan certificates called
Debentures. The total amount to be borrowed is divided into units of fixed amount say of
Rs.100 each. These units are called Debentures. These are offered to the public to
subscribe in the same manner as is done in the case of shares. A debenture is issued under
the common seal of the company. It is a written acknowledgement of money borrowed .
It specifies the terms and conditions, such as rate of interest, time repayment, security
offered, etc.

Types of Debentures :
Debentures may be classified as:
a) Redeemable Debentures and Irredeemable Debentures
b) Convertible Debentures and Non-convertible Debentures.
Redeemable Debentures :
These are debentures repayable on a pre-determined date or at any time prior to their
maturity, provided the company so desires and gives a notice to that effect.
Irredeemable Debentures :
These are also called perpetual debentures. A company is not bound to repay the amount
during its life time. If the issuing company fails to pay the interest, it has to redeem such
debentures.
Convertible Debentures :
The holders of these debentures are given the option to convert their debentures into
equity shares at a time and in a ratio as decided by the company.
Non-convertible Debentures:
These debentures cannot be converted into shares.

3. Public Deposits :

General public also like to deposit their savings with a popular and well established
company which can pay interest periodically and pay-back the deposit when due. It is a
very old source of finance in India. When modern banks were not there, people used to
deposit their savings with business concerns of good repute. Even today it is a very
popular and convenient method of raising medium term finance. The period for which
business undertakings accept public deposits ranges between six months to three years.

Procedure to raise funds through public deposits:

An undertaking which wants to raise funds through public deposits advertises in the
newspapers. The advertisement highlights th achievements and future prospects of the
undertaking and invites the investors to deposit their savings with it. It declares the rate of
interest which may vary depending upon the period for which money is deposited. It also
declares the time and mode of payment of interest and the repayment of deposits. A
depositor may get his money back before the date of repayment of deposits for which he
will have to give notice in advance.

4. Retained earnings:

The company may not distribute the whole of its profits among its shareholders. It may
retain a part of the profits and utilize it as capital. Like an individual, companies also set
aside a part of their profits to meet future requirements of capital. Companies keep these
savings in various accounts such as General Reserve, Debenture Redemption Reserve
and Dividend Equalisation Reserve etc. These reserves can be used to meet long term
financial requirements. The portion of the profits which is not distributed among the
shareholders but is retained and is used in business is called retained earnings or
ploughing back of profits. As per Indian Companies Act., companies are required to
transfer a part of their profits in reserves. The amount so kept in reserve may be used to
buy fixed assets. This is called internal financing.

5. Term loans from banks:

Many industrial development banks, cooperative banks and commercial banks grant
medium term loans for a period of three to five years. Traditionally, commercial banks in
India do not grant long term loans. They grant loans only for short period not extending
one year. But recently they have started giving loans for a long period. Commercial banks
give term loans i.e. for more than one year. The period of repayment of short term loan is
extended at intervals and in some cases loan is given directly for a long period.
Commercial banks provide long term finance to small scale units in the priority sector.

6. Loan from financial institutions:

There are many specialised financial institutions established by the Central and State
governments which give long term loans at reasonable rate of interest. Some of these
institutions are:
Industrial Finance Corporation of India ( IFCI),
Industrial Development Bank of India (IDBI),
Industrial Credit and Investment Corporation of India (ICICI),
Unit Trust of India ( UTI ),
State Finance Corporations etc.

7. Warrant
A derivative security that gives the holder the right to purchase securities (usually equity)
from the issuer at a specific price within a certain time frame. Warrants are often included
in a new debt issue as a "sweetener" to entice investors. The main difference between
warrants and call options is that warrants are issued and guaranteed by the company,
whereas options are exchange instruments and are not issued by the company. Also, the
lifetime of a warrant is often measured in years, while the lifetime of a typical option is
measured in months.

8. Venture capital

Venture capital is financial capital provided to early-stage, high potential, growth 

startup companies. The venture capital fund makes money by owning equity in the
companies it invests in, which usually have a novel technology or business model in high
technology industries, such as biotechnology, IT, Software etc. The typical venture
capital investment occurs after the seed funding round as growth funding round (also
referred as Series A round) in the interest of generating a return through an eventual
realization event, such as an IPO or trade sale of the company.

9. Convertible note
Convertible note (or, if it has a maturity of greater than 10 years, a convertible
debenture) is a type of bond that the holder can convert into shares of common stock in
the issuing company or cash of equal value, at an agreed-upon price. It is a hybrid
security with debt- and equity-like features. Although it typically has a low coupon rate,
the instrument carries additional value through the option to convert the bond to stock,
and thereby participate in further growth in the company's equity value. The investor
receives the potential upside of conversion into equity while protecting downside with
cash flow from the coupon payments.
From the issuer's perspective, the key benefit of raising money by selling convertible
bonds is a reduced cash interest payment. However, in exchange for the benefit of
reduced interest payments, the value of shareholder's equity is reduced due to the stock
dilution expected when bondholders convert their bonds into new shares.

Sources of Short-term Finance

The main sources of short-term finance are as follows:

1. Trade Credit

Trade credit refers to credit granted to manufactures and traders by the suppliers of raw
material, finished goods, components, etc. Usually business enterprises buy supplies on a
30 to 90 days credit. This means that the goods are delivered but payments are not made
until the expiry of period of credit. This type of credit does not make the funds available
in cash but it facilitates purchases without making immediate payment. This is quite a
popular source of finance.

2. Bank Credit

Commercial banks grant short-term finance to business firms which is known as bank
credit. When bank credit is granted, the borrower gets a right to draw the amount of credit
at one time or in installments as and when needed. Bank credit may be granted by way of
loans, cash credit, overdraft and discounted bills.
(i) Loans
When a certain amount is advanced by a bank repayable after a specified period, it is
known as bank loan. Such advance is credited to a separate loan account and the
borrower has to pay interest on the whole amount of loan irrespective of the amount of
loan actually drawn. Usually loans are granted against security of assets.

(ii) Cash Credit

It is an arrangement whereby banks allow the borrower to withdraw money upto a
specified limit. This limit is known as cash credit limit. Initially this limit is granted for
one year. This limit can be extended after review for another year. However, if the
borrower still desires to continue the limit, it must be renewed after three years. Rate of
interest varies depending upon the amount of limit. Banks ask for collateral security for
the grant of cash credit. In this arrangement, the borrower can draw, repay and again
draw the amount within the sanctioned limit. Interest is charged only on the amount
actually withdrawn and not on the amount of entire limit.

(iii) Overdraft
When a bank allows its depositors or account holders to withdraw money in excess of the
balance in his account upto a specified limit, it is known as overdraft facility. This limit is
granted purely on the basis of credit-worthiness of the borrower. Banks generally give the
limit upto Rs.20,000. In this system, the borrower has to show a positive balance in his
account on the last friday of every month. Interest is charged only on the overdrawn
money. Rate of interest in case of overdraft is less than the rate charged under cash credit.

(iv) Discounting of Bill

Banks also advance money by discounting bills of exchange, promissory notes and
hundies. When these documents are presented before the bank for discounting, banks
credit the amount to cutomer’s account after deducting discount. The amount of discount
is equal to the amount of interest for the period of bill.

3. Customers’ Advances
Sometimes businessmen insist on their customers to make some advance payment. It is
generally asked when the value of order is quite large or things ordered are very costly.
Customers’ advance represents a part of the payment towards price on the product which
will be delivered at a later date. Customers generally agree to make advances when such
goods are not easily available in the market or there is an urgent need of goods. A firm
can meet its short-term requirements with the help of customers’ advances.

4. Installment credit

Installment credit is now-a-days a popular source of finance for consumer goods like
television, refrigerators as well as for industrial goods. You might be aware of this
system. Only a small amount of money is paid at the time of delivery of such articles.
The balance is paid in a number of installments. The supplier charges
interest for extending credit. The amount of interest is included while deciding on the
amount of installment. Another comparable system is the hire purchase system under
which the purchaser becomes owner of the goods after the payment of last installment.
Sometimes commercial banks also grant installment credit if they have suitable
arrangements with the suppliers.

5. Loans from Co-operative Banks

Co-operative banks are a good source to procure short-term finance. Such banks have
been established at local, district and state levels. District Cooperative Banks are the
federation of primary credit societies. The State Cooperative Bank finances and controls
the District Cooperative Banks in the state. They are also
governed by Reserve Bank of India regulations. Some of these banks like the Vaish Co-
operative Bank was initially established as a co-operative society and later converted into
a bank. These banks grant loans for personal as well as business purposes. Membership is
the primary condition for securing loan. The functions of these banks are largely
comparable to the functions of commercial banks.

6. Commercial paper
commercial paper is an unsecured promissory note with a fixed maturity of 1 to 270 days.
Commercial Paper is a money-market security issued (sold) by
large banks and corporations to get money to meet short term debt obligations (for
example, payroll), and is only backed by an issuing bank or corporation's promise to pay
the face amount on the maturity date specified on the note. Since it is not backed
by collateral, only firms with excellent credit ratings from a recognized rating agency will
be able to sell their commercial paper at a reasonable price. Commercial paper is usually
sold at a discount from face value, and carries higher interest repayment rates than bonds.
Typically, the longer the maturity on a note, the higher the interest rate the issuing
institution must pay. Interest rates fluctuate with market conditions, but are typically
lower than banks' rates