Commercial Loans
Bill can try and get a commercial loan. A commercial loan is a bank loan where Bill or his company executes a promissory note, which is an unconditional promise to pay, and agrees to pay the bank the principal amount of the loan in addition to an amount of interest for use of the money. Commercial loans may be secured or unsecured loans.
A secured loan means that Bill has pledged collateral that the bank can take and sell to satisfy Bill's loan obligation if he defaults. An unsecured loan is a loan where the bank is not protected with collateral. It's not always easy to obtain a commercial loan, as banks are very cautious about lending money to smaller businesses without a significant track record and assets.
Stock Offering
Bill can also offer stock to help raise funds for his new expansion. Stock is an ownership interest in a corporation. For example, let's say Bill needs three million dollars to make it through the first two years of expansion before he thinks sales revenue will be sufficient to start covering operating expenses. If he can find investors interested in his company, he can offer them shares of his company in exchange for cash.
Of course, this means Bill is no longer the only owner of his company. In fact, he may lose control of his company if he doesn't maintain control of a majority of the stock. He'll also be under pressure from his shareholders to perform because they expect a return on their investment in the form of dividends, which are distributions of corporate profits. Since a stock is a security, an offering of stock is regulated by the SEC and state securities agencies.
Debt Offering
There's more than one way to finance a business through debt. Rather than going to a bank, Bill can go to individual investors. Bill can offer debentures, which are debt instruments, such as corporate bonds, to investors. Instead of getting a loan from a commercial bank, Bill, in essence, is getting a loan from several different investors. While these investors will not own part of his company, they are creditors and will expect prompt payment. Like a stock offering, offering debentures is regulated by the SEC and state securities agencies.
Government Programs
Bill can also look into government programs. Sometimes states and the federal government may provide grants and offer loan programs to support small businesses or encourage the growth of certain industries. For example, Bill could look into the Small Business Administration's loan programs.
If Bill's company was engaged in scientific research or other areas of business that the government wants to encourage and develop, there may be government grants available for which he could apply. Government grant and loan programs usually require strict compliance and may require reporting by recipients. Loans must be paid back, but grants don't have to be.
Lesson Summary
Let's review what we've learned. Long-term financing is the use of credit with a maturity date of over a year. Long-term financing is often needed to finance business expansions or for the purchase of capital assets, such as land, factories and equipment.
Businesses have several different options when seeking long-term financing. Businesses may seek long-term financing from a bank. Businesses may also take a dip into securities and offer stock or debentures to investors to raise capital. Finally, some businesses may qualify for special government loans or grants.
Learning Outcomes
When this lesson is finished, you should be able to:
- Define long-term financing
- Understand why long-term financing is sometimes necessary in business
- Explain how the different types of long-term financing work, including commercial loans, stocks, debentures and government programs
