Pledged Shares Meaning
Pledged shares are those shares that are transferred to the lender as collateral security by the promoters of the company to raise fund or to take a loan in order to meet the business requirements i.e. working capital requirement, funding for business or raising fund for any new projects as well as for the personal requirements. .
Promoters of company pledge shares & uses shares as collateral security for getting a loan to meet the requirement of business or to meet personal fund requirements. For business, the loan can be taken to meet the working capital requirements, loans for acquiring new business, for starting new projects and for acquiring assets. It is different for the hypothecation of assets. In pledging of shares, shares will be in name of promoters but it will be transferred to the bank as security of the loan. Till repayment of loan promoters can’t transfer ownership of shares. It is only preferable when promoters are assured about performance and inflow of business in the future and with that inflow they can repay the loan.
How does Pledged Shares Work?
Upon pledging the shares, the promoters cannot trade their shares unless they repay the loan amount. The lender will provide the loan of an amount which is considerably less than the value of shares as on that date because the market is dynamic and unpredictable. In the case of a bank and a financial institution, different lenders have different rules and the different rates at which they provide the loan based on the market value of the shares.
As we know that, the market is dynamic and unpredictable; so one cannot predict whether the value of pledged shares going to rise or going to fall in the future. So, for making sure that the lenders have enough security against the loan, they provide clause or terms & conditions in their contract with the promoters where promoters have to provide cash or pledge more shares in case there is a fall in the market value of the shares. In case of fall in the market value of shares, the promoters have to maintain the value of securities with the bank for which promoters may have to introduce balance as cash or further pledged their shares to cover the gap between the ‘amount needed for security’ and the ‘market value of the pledged share’.
If in case of a fall in the market value of the shares, promoters are not able to provide more security to the lenders, then the lenders may reserve the right of selling the shares to recover the amount in their contract. In the contract, the lender already mentions the minimum amount that must be recoverable from the pledged shares, in case the market value of the shares falls from that minimum recoverable amount then the lender may sell the shares in the market to recover the best amount that seems possible. In case, this scenario occurs then there are chances of fall in the market value of that company as the stakeholders may become insecure for the future performance of the company and may decide to pull out their holdings which may lead to panic in the other stakeholders and further fall in the market value of the company. That is the reason why it is considered as the last resort for the company.
Example of Pledged Shares
ABC Limited is a public company listed on a stock exchange and it is a reputed company in the market. The market value of ABC limited is Rs.10000 million. Promoters of the company are holding 60 % of the total holding. Total equity shares of the company are 100 million shares of Rs. 10 each. Promoters holding are 60 million shares with a value of Rs.600 million. The company is performing very well and the inflow of the company is increasing day by day. As a company is growing rapidly promoters of the company are thinking about diversification. They want to acquire new business and for acquiring new business they require funding of Rs. 5000 million. Non-current assets of a company are already used as security for an existing loan but for Rs. 3000 million of funding they can give their non-current assets (i.e. building, plant, and machinery) as security means a loan of Rs. 3000 million will be secured on non-current assets. Cash credit of the company is already secured on currents assets (like debtor and stock) of the company.
As a company is healthy and growing and they are expecting good inflow and good performance from a new business so promoters are willing to secure a loan of Rs. 2000 million by pledging their shareholding. It means promoters are giving their shareholding as collateral security for Rs. 2000 million loans. For Rs. 2000 million loan promoters have to give 3000 million worth shareholding to the bank as collateral security. It means promoters of the company will give 30 million shares having market value 3000 million at the date when shares are given as security to the bank. The bank is ready to give a 67% amount as a loan of collateral security.
Promoters can pledge their shares to get funds for business or for personal requirements. The company considers this method as the last resort for availing funds from the lenders. Company doesn’t prefer to give shares for security because that can affect company‘s goodwill, the company keeps this as last option for funding, first, they prefer-current and current assets to give as security for raising fund and if all the assets are already given as a security to a bank or financial institution, then they try to get the unsecured loan on the basis of business and their goodwill.
But if the company is healthy, growing and the company is expecting good inflow in foreseeable future and is in a condition of repaying the loan installments timely, then it can raise funds by giving shares as collateral security against the loan amount.
This has been a guide to Pledged Shares and its Meaning. Here we discuss how does pledged shares work along with an example and detailed explanation. You can learn more about financing from the following articles –