Short-Term vs Long-Term Financing | LegalVision UK (2024)

When it comes to financing options, businesses often have to consider the duration of the funding they require. There are broadly two forms of financing: short-term financing and long-term financing. Understanding the differences between these two approaches will help you make informed decisions about the financial health and growth of your startup. In this article, we will compare and contrast short-term and long-term financing, their characteristics, and the implications they have on businesses.

What is Short-Term Financing?

Short-term financing refers to the capital borrowed or obtained for a shorter period, typically less than one year. It is primarily used to:

• address immediate funding needs;
• manage cash flow fluctuations; and
• acquire relatively low-valued but important assets and opportunities.

Various short-term financing options are available to businesses, including:

• trade credit;
• bank overdrafts;
• factoring; and
• invoice discounting.

Let us explore various forms of short-term financing.

Trade Credit

One of the most common forms of short-term financing is trade credit. It involves purchasing goods or services from suppliers on credit, which allows your startup to pay for the products at a later date. Trade credit terms can range from a few days to several months, providing businesses additional time to generate revenue from the sale of the purchased goods before settling the outstanding payment.

Bank Overdrafts

Bank overdrafts are another short-term financing option commonly utilised by businesses. It involves the arrangement with a bank where the business is allowed to withdraw funds exceeding the available balance in their bank account up to an agreed-upon limit. Bank overdrafts provide flexibility in managing cash flow fluctuations. This ensures that businesses have access to additional funds when needed to cover expenses or bridge temporary gaps in cash inflows.

Factoring

Factoring is a short-term financing solution that enables startups to convert their accounts receivable into immediate cash. It involves selling outstanding invoices to a third-party financial institution known as a factor. The factor assumes responsibility for collecting the payments from your customers. This allows businesses to access a portion of their accounts receivable upfront, providing a quick infusion of cash to support their operations or invest in growth opportunities.

Invoice Discounting

Similar to factoring, invoice discounting allows businesses to release cash in unpaid invoices. However, unlike factoring, the business retains control over the collections process and maintains a direct relationship with its customers. Invoice discounting allows businesses to borrow against the value of their outstanding invoices, enabling them to access funds that would otherwise be tied up until the customers make the payments.

Unlike factoring, invoice discounting is a form of borrowing.

Long-Term Financing

In contrast to short-term financing, long-term financing involves securing capital for an extended period, typically exceeding one year. It is primarily used for:

• major investments;
• expansion projects;
• acquiring assets; or
• funding the overall growth of the business.

Bank Loans

Bank loans are the most common form of long-term debt financing. Your startup borrows money from a bank, repays the interest amount over several years, and repays the full amount at the end of the period. Banks typically require security in your startup.

Bonds and Loan Notes

Bonds, often called loan notes, operate by your startup issuing notes to investors under the promise to make interest payments on the loans and repay the full amount at the end of the period. They are more complex than bank loans because they involve multiple investors, each of which may wish to sell their notes to other investors. This requires financial advisers to structure and manage the bond programme.

Equity Financing

Equity financing involves selling a portion of the business’s ownership to investors in exchange for capital. It is a long-term financing approach commonly used by startups and high-growth companies. By selling shares, businesses can raise funds without incurring debt. Equity financing allows investors to share in the business’s success and potential profits, but it also means relinquishing a degree of control and ownership.

Leasing

Leasing is relevant for businesses requiring access to high-valued assets like machinery, property, planes, or ships. Under a lease agreement, your startup enters into a contract with a lessor, which allows you to use the asset you require. In exchange, you pay the lessor periodic payments.

Key Takeaways

Short-term and long-term financing options reflect that businesses must manage their cash and capital for short-term and long-term use. Short-term financing provides quick access to capital for more urgent uses, while long-term financing supports sustainable growth and larger investments.

If you need help raising funds for your business, our experienced startup lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.

Frequently Asked Questions