Term loan

DEFINITATION

A term loan is a monetary loan that is repaid in regular payments over a set period of
time. Term loans usually last between one and ten years, but may last as long as 30
years in some cases. A term loan usually involves an unfixed interest rate that will add
additional balance to be repaid.
 The basic features of term loan

1. Security:
Term loans are secured loans. Assets which are financed through term loans serve as primary security
and the other assets of the company serve as collateral security.

2. Obligation:
Interest payment and repayment of principal on term loans is obligatory on the part of the borrower.
Whether the firm is earning a profit or not, term loans are generally repayable over a period of 5 to 10
years in installments.

3. Interest:
Term loans carry a fixed rate of interest but this rate is negotiated between the borrowers and lenders
at the time of dispersing of loan.

4. Maturity:
As it is a source of medium-term financing, its maturity period lies between 5 to 10 years and
repayment is made in installments.

5. Restrictive Covenants:
Besides asset security, the lender of the term loans imposes other restrictive covenants to themselves.
Lenders ask the borrowers to maintain a minimum asset base, not to raise additional loans or to repay
existing loans, etc.

6. Convertibility:
Term loans may be converted into equity at the option and according to the terms and conditions laid
down by the financial institutions.
 Advantages of term loans

i. From Point of View of the Borrower:

• Cheap: It is a cheaper source of medium-term financing.

• Tax Benefit: Interest payable on term loan is a tax deductible expenditure and thus taxation benefit
is available on interest.

• Flexible: Term loans are negotiable loans between the borrowers and lenders. So terms and condi-
tions of such type of loans are not rigid and this provides some sort of flexibility.

• Control: Since term loans represent debt financing, the interest of the equity shareholders are not
diluted

ii. From Point of View of the Lender:

• Secured: Term loans are provided by banks and other financial institutions against security—so
term loans are secured.

• Regular Income: It is obligatory on the part of the borrower to pay the interest and repayment of
principal irrespective of its financial position—hence the lender has a regular and steady income.

• Conversion: Financial institutions may insist the borrower to convert the term loans into equity.
Therefore, they can get the right to control the affairs of the company.
 Disadvantages of Term Loans

Term loans have several disadvantages which are discussed below.

i. From Point of View of the Borrower:
• Obligation: Yearly interest payment and repayment of principal is obligatory on the part of bor-
rower. Failure to meet these payments raises a question on the liquidity position of the borrower
and its existence will be at stake.

• Risk: Like any other form of debt financing term loans also increases the financial risk of the com-
pany. Debt financing is beneficial only if the internal rate of return of the concern is greater than its
cost of capital; otherwise it adversely affects the benefit of shareholders.

• Interference: In addition to collateral security, restrictive covenants are also imposed by the lenders
which lead to unnecessary interference in the functioning of the concern.

ii. From Point of View of the Lender:

• Negotiability: Terms and conditions of term loans are negotiable between borrower and lenders
and thus it sometimes can affect the interest of lenders.

• Control: Like other sources of debt financing, the lenders of term loans do not have any right to
control the affairs of the company.
 Long-Term Loans

These are the loans taken for a fairly long duration of time ranging from 5 years to 10 or 15 years.
Long-term loans are raised to meet the financial requirements of enterprise / company for acquiring
the fixed assets which include the following:
(i) Land and site development
(ii) Building and civil works
(iii) Plant and machinery
(iv) Installation expenses
(v) Miscellaneous fixed assets comprising vehicles, furniture and fixtures, office equipment and so on.
In case of units to be located in backward areas, another element of miscellaneous fixed cost includes
expenditure to be incurred in infrastructure facilities like roads, railway sidings, water supply, power
connection, etc., Term-loans, or say, long-term loans are also required for expansion of productive
capacity by replacing or adding to the existing equipment.
 Short Term Loans
Short term loans come in various forms, as listed below:

1. Merchant cash advances

This type of short term loan is actually a cash advance but one that still operates like a loan. As such, the lender loans the
amount needed by the borrower. The borrower makes the loan payments by allowing the lender to access the borrower’s
credit facility. Each time a purchase by a customer of the borrower is made, a certain percentage of the sale is taken by the
lender.

2. Lines of credit
It is much like using a business credit card. A credit limit is set and the business is able to tap into the line of credit as
needed. It makes monthly installment payments against whatever amount has been borrowed. Therefore, monthly
payments due will vary in accordance with how much of the line of credit has been accessed. One advantage of lines of
credit over business credit cards is that the former typically charges a lower annualpercantage rate (APR).

3. Payday loans
Payday loans are emergency short term loans that are relatively easy to obtain. Even high street leader offer them. The
drawback is that the entire loan amount, plus interest, must be paid in one lump sum when the borrower’s payday arrives.
Repayments are typically done by the lender taking out the amount from the borrower’s bank account, using the
continuous payment authority.

4. Online or Installment loans

It is also relatively easy to get a short term loan where everything is done online – from application to approval. Within
minutes from getting the loan approval, the money is wired to the borrower’s bank account.

5. Invoice financing
This type of loan is done by using a business’ accounts receivables – invoices that are, as yet, unpaid by customers. The
lender loans the money and charges interest based on the number of weeks that invoices remain outstanding. When an
invoice gets paid, the lender will interrupt the payment of the invoice and take the interest charged on the loan before
returning to the borrower what is due to the business.
 Sources of Term-Loans:

The following are the sources of raising term loans.

1. Issue of shares
2. Issue of Debentures
3. Loans from Financial Institutions
4. Loans from Commercial Banks
5. Public Deposits
6. Retention of Profits.

These are explained in the following pages:

Shares:
Share is unit into which the total capital of a company is divided. As per Section 85 of the Companies Act, 1956, a
public limited company can issue the following two kinds of shares:
(1) Preference Shares, and
(2) Equity Shares.
Preference Shares:
These are the shares which carry a preferential right over equity shares with reference to dividend. They also carry a
preferential right over equity shares with reference to the payment of capital at the time of winding up or repayment
of capital. The preference shares may be of various types such as cumulative and non-cumulative, redeemable and
irredeemable, participating and non-participating and convertible and non-convertible.
• Equity Shares:
Shares which are not preference share are equity shares. In other words, equity shares are entitled to dividend and
capital after the payment of dividend and capital on preference shares. Based on the types of shares, there are two
types of capitals:
(i) Preference Share Capital, and
(ii) Equity Share Capital.
 Sources of Short-Term Finance

Short-term finance is obtained for a period up to one year. These are required to meet the day-
to-day business requirements. In other words, short-term finance is obtained to meet the
working capital requirements of the enterprise.
The sources of short-term finance can include but not confined to the following only:
1. Loans from Commercial Banks
2. Public Deposits
3. Trade Credit
4. Factoring
5. Discounting Bills of Exchange
6. Bank Overdraft and Cash Credit
7. Advances from Customers
8. Accrual Accounts.
 EXTERNAL COMMERCIAL BORROWINGS (ECB)

Indian companies are allowed to access funds from abroad in the following methods:
(i) External Commercial Borrowings (ECB): ECBs refer to commercial loans in the form of bank loans, securitized
instruments (e.g. floating rate notes and fixed rate bonds, non-convertible, optionally convertible or partially
convertible preference shares), buyers’ credit, suppliers’ credit availed of from non-resident lenders with a minimum
average maturity of 3 years.

(ii) Foreign Currency Convertible Bonds (FCCBs): FCCBs mean a bond issued by an Indian company expressed in
foreign currency, and the principal and interest in respect of which is payable in foreign currency. The bonds are
required to be issued in accordance with the scheme viz., "Issue of Foreign Currency Convertible Bonds and Ordinary
Shares (Through Depositary Receipt Mechanism) Scheme, 1993”, and subscribed by a non-resident in foreign
currency and convertible into ordinary shares of the issuing company in any manner, either in whole, or in part, on
the basis of any equity related warrants attached to debt instruments. The ECB policy is applicable to FCCBs. The
issue of FCCBs is also required to adhere to the provisions of Notification FEMA No. 120/RB-2004 dated July 7, 2004,
as amended from time to time.

(iii) Preference shares: Preferences Shares (i.e. non-convertible, optionally convertible or partially convertible) for
issue of which, funds have been received on or after May 1, 2007 would be considered as debt and should conform
to the ECB policy. Accordingly, all the norms applicable for ECB, viz. eligible borrowers, recognized lenders, amount
and maturity, end use stipulations, etc. shall apply. Since these instruments would be denominated in Rupees, the
rupee interest rate will be based on the swap equivalent of LIBOR plus the spread as permissible for ECBs of
corresponding maturity.

(iv) Foreign Currency Exchangeable Bonds (FCEBs): FCEBs means a bond expressed in foreign currency, the principal
and interest in respect of which is payable in foreign currency, issued by an Issuing Company and subscribed to by a
person who is a resident outside India, in foreign currency and exchangeable into equity share of another company,
to be called the Offered Company, in any manner, either wholly, or partly or on the basis of any equity related
warrants attached to debt instruments.
 Foreign Currency Term Loan(FCTL)

Foreign Currency Term Loan(FCTL)/Foreign Currency Demand Loan(FCDL)

Foreign Currency Term Loan(FCTL) and Foreign Currency Demand Loan(FCDL) are
provided to Mid / Large corporates having turnover of Rs.500 Crores and above for
extending long term credit facilities

Purpose of the loan is to extend long term credit facilities to entrepreneurs:

• Expansion & Modernizations
• Substitution of high cost debts / high cost term debts of other Banks / FIs.
• Up-gradation of technology & energy conservation schemes / machinery.
• Design and introduction of new layouts in the factory to enhance productivity.
• Acquisition of software, hardware, consumable tools, jigs, fixtures etc
• Acquisition of ISO and other similar certifications.