Do you know what is term loan? you might or might not know, what is a term loan. Hopefully, by the end of this blog, you would be able to understand what is a term loan with its features, pros& cons.
we are gonna learn today
- What is Term Loan?
- What are the factors you should consider while you opt for term financing?
- Here are some financial institutions which provide term loan.
- Features of term finance
- What are the advantages of finance from Term finance?
- What are the disadvantages of finance from Term finance?
What is Term Loan?
Term loans, also referred to as Term financing, are generally raised by the business concerns from financial institutions to meet their medium-term and long-term financial needs.
In short, the amount raised from term loan is used mainly for the purpose of financing fixed assets and to meet permanent working capital.
Term loans are also known as term or project finance.
Medium-term loans are granted for periods ranging from one to five years and for periods beyond 5 years, long term loans are granted.
It is used for the purpose of expansion, diversification, and modernization as well as to redeem preference capital, debentures, or bonds.
most importantly, term finance carries low cost but involve high risk.
It does not affect control but reduces managerial freedom to some extent.
In short, the term loan carries a moderate rate of interest and is payable through installments.
In other words, a term loan is granted on the basis of a written agreement between the borrower and the lending institution.
The main features of term financing are security, interest, principal repayment, and conditions of the lender.
What are the factors you should consider while you opt for term financing?
- Nature of the business
- Cost of fixed assets and current assets
- scale of operation
- production cycle
- business cycle
- cost of credit
- Seasonality and production policy of the company
- credit policy of the company
- growth and expansion of the company
- operating efficiency of the company
- availability of raw materials
- rice in price- level
- depreciation policy and its impact
- tax liability of the company
- Dividend and retention policy of the company, etc.
Term loans may take the form of an ordinary loan or a revolving credit to the firm.
In short, term loans are being provided mainly by commercial banks and specialized financial institutions or development banks in India.
Some major financial institutions which provide term loan
IFCI is the first term finance institution in India. It was set up as a statutory corporation in 1948.
In other words, particularly in circumstances where normal banking accommodation is inappropriate or recourse to the capital issue method is unachievable.
however, its purpose is to Industrial development of relativity developed districts/ areas in the country, the growth of industries in the cooperative sector,
The corporation pays due attention to the need for the spread of new industries. In 1993, IFCI was converted into a public limited company.
In short, the objective of the corporation is to make medium and long term credits more available to individual concerns in India.
And the reasonably well-developed investment portfolio for itself.
The IFCI was set up to offer financial assistance to only large and medium-sized undertakings while SFCs were set up to offer financial assistance to small and medium-sized industrial concerns.
In addition, SFCs render support to all kinds of industries which may be in the form of private limited companies, partnership firms, or sole trading concerns.
In conclusion, there are altogether 18 SFCs functioning in the country at present.
Industrial credit and investment corporation of India limited(ICICI)
The ICICI was set up on January 5, 1955, as a public limited company by the government of India, the World Bank, and officers of the Indian private industry.
The main objective of setting up of ICICI for developing medium and small industries of the private sector.
on the other hand, It provides foreign currency loans to industrial projects and provides finance in the form of long or medium-term loans.
The date of enforcement of UTI is February 1, 1964, under the unit trust of India act, 1963.
In short, it was a closed-end mutual fund to organize the resources/savings of small investors.
certainly, The main objective of the UTI was to pull the savings of the middle and low-income groups and thus developed the savings habit of the people.
In addition, as the UTI has long term available funds it can assist financially the industrial organizations by subscribing directly to their equity shares, preference shares, debentures, bonds, and also by providing short term finance or loan.
Small industrial development Bank of India (SIDBI)
SIDBI was set up in April 1990 under the small industries development Bank of India act.
The main objective of SIDBI has been to work as a principal financial institution for the promotion, financing, growth, and development of industries in the small scale sector in India.
Moreover, it coordinates with the functions of the financial institutions, viz. SFCs, state small industries development corporations, scheduled banks and state cooperative banks, etc.,
subsequently, it engaged in the promotion, Financing, growth, and developing the small scale industries.
NIDC was set up in 1954. NIDC provides capital, credit, machinery, equipment, loans and advances, subscriptions, underwriting and guaranteeing of loans and advances to both private and public sector companies.
Features of Term Loans:
- In India, financial institutions provide term loans generally for a period of 6 to 10 years. A grace period of 1 to 2 years may be allowed in some cases.
- A fixed-rate of interest is related to any kind of term loan. The borrower has to pay the interest mandatory.
- most importantly, a borrower may have to pay a commission charge if he does not utilize or draw the total amount of loan allowed by the lender in his favor.
- In addition, the term loans can be negotiated between the borrowers and the lenders.
- To sum up, repayment of the loan can be made annually, half-yearly, or quarterly as per the requirements of the lending institutions after allowing an initial Grace period of 1-2 years.
Advantages of term finance:
For the Borrowers
- The cost of term financing is much lower than the cost of equity capital or preference capital financing.
- Term loan financing does not result in dilution of control since the lenders of term financing are not entitled to vote.
- Interest paid on term loans is a compulsory payment and thus it is a charge against profit.
- So, the borrowers can get the benefit of tax deductibility regarding interest payment which also lowers the cost of term financing.
For the Lender:
- Term loans earn a fixed rate of interest which signifies a permanent regular source of income.
- The lender does not face any risk to provide term loans together with interest and other charges, remain fully secured.
- In addition, Term loans have a definite maturity period which helps the lender to plan for or a proper rollover the amount.
- Incorporating a restrictive contract in the term loan agreement protects the interest of the lender.
Disadvantages of Term Loans:
To the borrower:
- The term loan agreement may contain several restrictive terms and conditions, known as covenants. These may be diminishing to the interest of the borrower and may reduce managerial freedom.
- The interest payment and capital repayment are a compulsory statutory duty. Failure to meet these payments can cause a lot of embarrassment, it can even pressurize the existence of the borrower’s business.
- most importantly, term loan financing enhances the financial risk associated with the firm for which the market price of equity shares may fall. This may increase the overall cost of capital.
- In addition, financial institutions may force the borrower company to appoint their nominee on the board which may cause involvement in the decision-making process of the company.
- Above all, not only in the case of failure, even for a little default in payment for interest or repayment of the loan, the borrower required to pay penal interest.
To the lender:
- certainly, Negotiable securities do not represent term loans.
- Term loans cannot be securitized like debentures or bonds against the loan which is negotiated in favor of others.
- most importantly, term loans don’t carry the right to vote. So, the lender of term loans cannot participate in the management of the company.
for instance, Development bank like ICICI provides long and medium-term finance or Term lending to the agricultural or industrial sector for the development of the country.
The amount raised from term loans is used:
Firstly, for the purpose of financing fixed assets.
Secondly, to meet permanent working capital.
In conclusion, A fixed-rate of interest is associated with any kind of term loans.
certainly, the borrower has to pay the interest compulsorily.
So, guys, I hope I solved your problems regarding the issue of Term financing.
A. Financial Institution like SIDBI provides Term lending to the small scale industries for their development.
A. Term loan financing does not result in dilution of control since the lenders of term financing are not entitled to vote.
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A commerce student from Kolkata.