Term Loan or Project Finance – A Long

Term Source of Finance

The term loan is a long term secured debt extended by banks or financial institutions
to the corporate sector for carrying out their long-term projects maturing between 5
to 10 Years which is normally repaid in monthly or quarterly equal installment. They
are an external source of finance paid in installments governed by loan agreement
and covenants.

All the capital requirements cannot be fulfilled by the promoters

or equity share issues and that is where the term loans come into the
picture. Term loan or project finance is a long term source of finance
for a company normally extended by financial institutions or banks for
a period of more than 5 years to a maximum of around 10 years. One
common feature which helps management in relatively substituting
equity by term loans is the longer term of the loan.
Suitable for:
The term loan is a type of funding which is most suitable for projects
involving very heavy investment which is not possible by an individual
or promoters. Big projects cannot be concluded in a year or two.

To yield return from them, the long-term perspective is required. Such

big ventures are normally financed by big banks and financial
institutions. If the investment is too large, several banks come together
and finance it. Such type of term loan funding is also called as
consortium loan.

The term loan is acquired for new projects, diversification of business,

expansion projects, or for modernization or technology upgradations.
Here also, the underlying fact is that the investment in these projects
is normally very huge. Lack of option of funding from other sources
such as equity etc for any reason also directs a company to go for the
term loan.

FINANCIAL LEVERAGE AND TERM LOAN

At times, an important reason for selecting term loan is financial
leverage. By opting for debt finance like term loan, a company tries to
magnify the returns to their equity shareholders. This help management
of a company achieve the core objective of wealth maximization for
its shareholders and also preserve the control and share of
existing shareholders.

FEATURES OF TERM LOAN

LOAN IN ANY CURRENCY
These loans are provided both in the home or foreign currency. Home
currency loans are offered normally for a purchase of fixed assets such
as land, building, plant and machinery, preliminary and preoperative
expenses, technical know-how, working capital etc. On the other hand,
foreign currency loans are offered for import of certain plant or
machinery, payment of foreign consulting fee etc.

SECURED LOAN
Term loans come under secured category of loans. Two kinds of
securities are there – primary and collateral. Primary security is the
asset which is purchased using the loan amount and collateral security
is the charge on other assets of the borrower.

LOAN INSTALMENTS
Repayment of the loan is done in installments. These installments
cover both principal and interest. Normally, loan installments are
decided by banks based the borrower’s cash flow capacity. There may
be installments paid monthly, quarterly, biannually, or even annually.
Installments are normally equal but they may be structured based on
the borrower’s business. Moratorium or grace period is also given by
banks in which no installment or very low installment is asked from the
borrower. Sometimes, small installments are kept in the initial year or
two and then the remaining loan is split into the remaining maturity
period making the later installments higher than the initial ones.

MATURITY
Normally a term loan is ranging between 5 to 10 years. Forecasting for
more than 10 years in the current changing business environment is
very difficult.

LOAN AGREEMENT
An agreement is drafted between the borrower and the bank regarding
the terms and conditions of the loans which are signed by the borrower
and is preserved with a bank.

LOAN COVENANT
Debt covenants are a part of a loan agreement. They are certain
statements in the agreement which states certainly do’s and dont’s for
the company. They are normally related to use of assets, creation of
liabilities, cash flow, and control of the management. They are positive/
affirmative or negative in nature.