Discover the major sources of long-term financing in business — from equity and debentures to venture capital and retained earnings. This complete guide is perfect for BITM, BBA, and BBS students studying Fundamentals of Corporate Finance.
Thank you for reading this post, don't forget to subscribe!Introduction: Understanding Long-Term Financing
Every successful business needs capital — not just for day-to-day operations but also for growth, expansion, and innovation. That’s where long-term financing comes into play. It provides the backbone for acquiring fixed assets, funding major projects, and sustaining long-term development goals.
In corporate finance, long-term financing refers to funds that remain available for more than one year, typically ranging from 5 to 25 years. These funds are used to invest in projects that will yield benefits over time, such as establishing factories, acquiring equipment, or expanding into new markets.
For BITM, BBA, and BBS students, understanding the sources of long-term financing is crucial to mastering the fundamentals of corporate finance — especially for topics like capital structure, cost of capital, and financial management decisions.
What is Long-Term Financing?
Long-term financing is the process of obtaining funds to meet business needs for an extended period — typically more than one year. It helps businesses maintain liquidity while investing in long-term assets and strategic initiatives.
Definition:
“Long-term financing refers to the capital raised by a business for financing its long-term investments, with a repayment period extending beyond one year.”
Major Sources of Long-Term Financing
Long-term financing can come from both internal and external sources. Let’s explore the most common ones used by corporations worldwide.
1. Equity Shares
Equity shares (also known as ordinary shares) represent ownership in a company. Equity shareholders are the real owners and have voting rights.
Features:
- Permanent source of finance
- Dividend depends on company’s profit
- No repayment obligation
Advantages:
- Enhances company credibility
- No fixed interest burden
Disadvantages:
- Dilution of control
- Dividend payments are not tax-deductible
Example:
When a company issues new shares in the stock market to raise capital for expansion.
2. Preference Shares
Preference shares carry preferential rights over equity shares in terms of dividend payment and repayment at liquidation.
Features:
- Fixed rate of dividend
- No voting rights (generally)
- Hybrid security (debt + equity characteristics)
Advantages:
- Stable income for investors
- Less risky than equity
Disadvantages:
- Fixed obligation for the company
- Limited participation in company’s profit
3. Debentures or Bonds
Debentures are long-term debt instruments issued by a company to borrow money at a fixed interest rate.
Features:
- Interest paid periodically
- Repayment after fixed tenure
- Can be secured or unsecured
Advantages:
- Tax-deductible interest
- No dilution of ownership
Disadvantages:
- Fixed financial burden
- Risk of default during poor financial performance
Example:
A company issuing 10-year bonds to raise $10 million for plant construction.
4. Term Loans from Financial Institutions
Term loans are loans provided by banks and financial institutions for 5 to 15 years.
Features:
- Regular interest payments
- Collateral required
- Flexible repayment schedules
Advantages:
- Easily available from banks
- Tax benefits on interest
Disadvantages:
- High interest rates
- Requires security or guarantees
Example:
Loans from institutions like the Industrial Development Bank or commercial banks for machinery purchase.
5. Retained Earnings (Internal Financing)
Retained earnings refer to profits that are reinvested in the business instead of being distributed as dividends.
Features:
- No external borrowing
- No fixed cost or interest
Advantages:
- Cheapest source of finance
- Increases business value over time
Disadvantages:
- Limited availability
- May reduce dividends to shareholders
6. Lease Financing
In lease financing, a business uses an asset (like machinery or vehicles) for a fixed period by paying rent, without owning it.
Advantages:
- Avoids heavy upfront investment
- Provides tax benefits
Disadvantages:
- Ownership remains with lessor
- Long-term cost may be higher
7. Venture Capital
Venture capital involves investment in startups and high-growth businesses in exchange for equity ownership.
Features:
- High risk, high return
- Investors often provide managerial support
Advantages:
- Provides funding for innovative businesses
- Encourages entrepreneurship
Disadvantages:
- Loss of ownership control
- Profit sharing with investors
8. Private Equity
Private equity firms invest large sums in mature companies to improve operations and profitability.
Features:
- Usually long-term (5–10 years)
- Focused on business restructuring or expansion
Advantages:
- Access to strategic expertise
- Large-scale funding support
Disadvantages:
- Loss of management control
- High expectations from investors
9. External Commercial Borrowings (ECBs)
Companies can also raise long-term loans from foreign institutions at competitive interest rates.
Advantages:
- Access to large international capital
- Diversifies funding sources
Disadvantages:
- Currency risk
- Regulatory restrictions
Comparison Table: Internal vs. External Sources of Long-Term Finance
| Basis | Internal Sources | External Sources |
|---|---|---|
| Meaning | Funds generated within the organization | Funds raised from outside parties |
| Examples | Retained earnings, depreciation funds | Equity, debentures, loans |
| Cost of Capital | Low | Comparatively higher |
| Control | No dilution | May dilute control |
| Legal Formalities | Minimal | High |
| Risk | Low | Moderate to high |
Factors Affecting the Choice of Long-Term Financing Source
- Cost of Capital – Firms prefer cheaper options like retained earnings.
- Risk Profile – Equity is riskier than debt; choice depends on stability.
- Control Considerations – Owners may avoid equity to retain control.
- Tax Benefits – Debt is attractive due to interest deductibility.
- Flexibility – Financing should allow adaptability in future decisions.
- Availability of Funds – Market conditions determine accessibility.
Significance of Long-Term Financing in Corporate Finance
Long-term financing forms the financial foundation for a company’s sustainability. It ensures that long-term goals like plant expansion, technology adoption, or international diversification are achieved without liquidity issues.
It directly influences:
- Capital Structure
- Cost of Capital
- Profitability and Risk
- Investor Confidence
Conclusion
In conclusion, long-term financing is essential for achieving a company’s strategic objectives. Choosing the right source of long-term finance helps businesses optimize their capital structure, minimize cost, and maximize profitability.
For students of BITM, BBA, and BBS, mastering this topic strengthens their understanding of how businesses fund growth sustainably and strategically.
👉 Final Takeaway:
“Long-term financing is the fuel that drives a business toward sustainable success.”
Frequently Asked Questions (FAQs)
1. What are the main sources of long-term financing?
The major sources include equity shares, preference shares, debentures, term loans, retained earnings, lease financing, and venture capital.
2. Why is long-term financing important for business?
It ensures business expansion, financial stability, and long-term growth.
3. What is the difference between short-term and long-term financing?
Short-term finance covers operational needs (less than one year), while long-term finance supports capital investment (more than one year).
4. Which is the cheapest source of long-term financing?
Retained earnings are generally the cheapest since they don’t involve interest or dividend obligations.
5. What factors should be considered before choosing a long-term financing source?
Cost, risk, control, tax benefits, and availability of funds are key considerations.