Share pledging occurs when company founders or promoters pledge their personal shareholding as collateral to obtain loans, usually for business purposes. It is a common financing technique, but it has risks and benefits that must be considered carefully. Read on to learn about these benefits and risks in detail.
Understanding Share Pledging
Share pledging allows promoters to raise funds without immediately selling their shares and losing control or voting rights. The lender places a lien on the shares, and the borrower continues enjoying voting rights and dividends as long as loan terms are met. If the promoters default, the lender can seize and liquidate the shares to recover dues.
Overall, share pledging provides access to financing while allowing shareholder control to remain intact. To monitor pledged shares or manage investments effectively, using an online trading app can provide real-time insights and streamlined control over your portfolio.
Benefits of Pledging Shares
The major benefits of pledging shares are:
- Access to Immediate Capital: Share pledging provides rapid access to capital for company needs without waiting for traditional financing options to materialise. Funds can be secured in days instead of months.
- No Need to Liquidate Assets: Promoters get financing while retaining management control and ownership interests. Share pledging is less disruptive than outright asset or share sales to raise capital.
- Flexible Financing Option: Pledging arrangements allow customised terms tailored to the company’s cash flow abilities. There is flexibility on interest rates, tenures, principal repayment, etc.
- Lower Interest Rates: Interest rates are usually 0.5-1% lower than alternative borrowing rates since shares provide good collateral cover to the lender.
- Business Growth Opportunities: The influx of capital can fund working capital needs, capital investments, advertising, etc., to facilitate business growth and expansion.
Many promoters prefer using pledge shares as collateral because it avoids the immediate liquidation of valuable assets and leverage the rising trends in trading and investment platforms like a trading app to monitor their pledged holdings.
Risks of Pledging Shares
Mentioned below are the risks of pledging shares:
- Market Volatility: Share prices fluctuate constantly, and promoters can get caught on the wrong side of market swings. Falling share prices increase the risk of default and the loss of pledged shares.
- Loss of Control: Lenders may sell pledged shares to recover dues if share prices dip significantly. Promoters can lose significant management control and ownership interests this way.
- Reputation Risk: Defaulting on share-pledging contracts raises red flags regarding company stability among regulators, shareholders, creditors, etc.. This damages the promoter’s reputation.
- Overleveraging: Heavy reliance on share pledging builds an overleveraged position, increasing risk appetite beyond prudent levels.
- Stringent Loan Terms: As share prices decline, lenders may enforce accelerated repayment, higher interest rates, lower credit limits, etc., making liquidity management more challenging.
Conclusion
Share pledging provides quick access to capital for founders wanting to retain management control. However, the risks associated with a pledge in stock market financing, including market volatility and potential reputation damage, cannot be overlooked.
Promoters should have prudent share pledging limits, diversified collateral across lenders and pre-agreed contingencies in place with lenders. This balances the financing benefits with the risks.
