Long- term debt describes debt with a maturity period or payback time of over 12 months or more. This would include loans, mortgages and bonds. Also known as permanent debt it is often used to purchase assets that will take a year or more to pay for themselves. Long term debt is a way to finance businesses and often the financial plan of choice for a small business. Using this method of financing can give the company some advantages, such as:
- Fixed interest rates. This assists with a company’s operational income budget.
- The business can fully deduct the interest paid on the debt.
- None or reduced investor involvement. Using long term debt to finance company growth reduces the need to seek equity for alternative investors. As long as loans are paid responsibly the loan companies have no say in your business, unlike an investor who does have the right to comment and play a part in decision making for your company.
- It can help you build your business credit, so you are less likely to need to use your personal credit, which is beneficial for you and helps increase your businesses value.
- It reduces how much of the businesses cash flow is used when a long-term loan is obtained to make capital improvements i.e. adds value to your business.
The disadvantages need also to be considered:
- Long term loans normally contain a lot of restrictive clauses, including the what the business can engage in, management structures etc.
- If you company is new it is often difficult to get the long term loans as they often cannot provide enough information on the how the company is functioning.
- Financiers demand a considerable amount of information to carry out a credit evaluation.
- As they carry a higher risk to the lenders and are costly to service the interest charges can be higher. They may also demand some form of collateral in the form of the companies assets
So, a longer borrowing term, whilst an option to help a company’s growth it also carries a risk that if you overdo the borrowing you can find your business’ operating flexibility considerable reduced. The decision to add more debt needs to take into account that a sudden economic downturn could very quickly put a company out of business. It will also affect how lenders will view the company; too much debt means the company runs the risk of financial trouble. A small business owner needs to balance out the pros and cons of borrowing over the longer term to ensure his business remains viable and growth.