Sources and Instruments of Long-Term Finance: A Detailed Study
Long-term finance refers to funds raised for a period exceeding one year and is primarily used for acquiring fixed assets, business expansion, or project financing. Such funds are essential for the growth, sustainability, and stability of any organization.
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I. Sources of Long-Term Finance
The key sources of long-term finance can be broadly classified into owned funds and borrowed funds, as outlined below:
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1. Equity Shares (Ordinary Shares)
Equity shares represent ownership in a company. Equity shareholders have voting rights and share profits in the form of dividends.
Features: Permanent capital, no obligation to repay, high risk for investors, residual claim on profits.
Example: A startup raising ₹10 crore through issuing 1 lakh equity shares at ₹100 each.
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2. Preference Shares
Preference shareholders have preferential rights over equity shareholders in receiving dividends and capital repayment.
Features: Fixed interest rate, repayment after maturity.
Example: A manufacturing firm issues 10-year bonds worth ₹50 crore at 8% interest per annum.
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4. Term Loans from Financial Institutions and Banks
Long-term loans are provided by banks and financial institutions for project financing or expansion.
Tenure: Generally ranges from 3 to 10 years.
Repayment: Through installments.
Example: An infrastructure company avails a ₹100 crore loan from SIDBI for a 5-year period.
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5. Retained Earnings (Ploughing Back of Profits)
These are undistributed profits reinvested into the business instead of being distributed as dividends.
Advantages: No dilution of control, internal source.
Example: A company retains ₹15 crore profit annually for plant upgradation.
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6. Venture Capital and Private Equity
Startups and high-risk projects may raise funds from venture capitalists or private equity firms.
Characteristics: Equity investment, managerial support, exit through IPO or acquisition.
Example: A fintech startup receives ₹25 crore from a venture capital fund for product development.
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7. Public Deposits
These are unsecured deposits invited from the public by companies for a fixed term and interest rate.
Regulated by: Companies Act, 2013 and RBI guidelines.
Example: A company invites public deposits for 3 years at 9% interest rate.
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8. Foreign Direct Investment (FDI) and External Commercial Borrowings (ECB)
Companies can raise long-term capital from foreign investors or through ECBs under regulatory limits.
Example (FDI): A multinational invests ₹200 crore in an Indian pharma company.
Example (ECB): A listed company borrows $10 million from an international lender for R&D.
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II. Instruments of Long-Term Finance
The main instruments used to raise long-term funds are as follows:
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1. Shares (Equity & Preference)
Instruments issued to raise ownership capital.
Provides voting rights (equity) and fixed returns (preference).
Example: Initial Public Offering (IPO) or Rights Issue.
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2. Debentures/Bonds
Debt instruments issued to public or private investors.
Carry a fixed coupon rate and maturity.
Example: Government securities, corporate bonds.
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3. Term Loans
Loans issued by banks or financial institutions.
Usually secured by company assets.
Example: Project loans from IDBI or NABARD.
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4. Lease Financing
Alternative to purchasing assets; firms use them on lease.
Types: Operating lease, Financial lease.
Example: Leasing machinery from a finance company.
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5. Depository Receipts (ADR/GDR)
Instruments used by companies to raise capital from foreign markets.
ADR: Issued in U.S. markets; GDR: Global markets.
Example: Infosys raised capital through GDRs in European markets.
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6. Convertible Instruments
Instruments like convertible debentures that can be converted into equity after a specific period.
Helps reduce immediate dilution and future capital increase.
Example: A company issues ₹20 crore worth of debentures convertible into shares after 5 years.
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7. Zero-Coupon Bonds
Bonds issued at a discount with no periodic interest but redeemable at face value.
Suitable for long-term investors.
Example: A zero-coupon bond issued at ₹800, redeemable at ₹1,000 after 10 years.
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Conclusion
Long-term finance plays a critical role in supporting a company’s capital expenditures, strategic investments, and growth initiatives. Companies must carefully choose between various sources and instruments based on cost, risk, flexibility, and control. A balanced mix of owned and borrowed funds ensures sustainable financial health and strategic agility in a competitive environment.
