Shareholders Loan

What is Shareholders Loan?

Shareholder’s Loan is a form of financing falling under the debt category, where the source of financing is the shareholders of the company and that is why it is called so, this loan is of subordinate level, wherein the repayment happens after all other liabilities are paid off and even the interest payment is generally deferred as per the terms of the loan indenture.

Explanation

  • Shareholders Loan is another form of financing that the companies go for when they are at a very initial stage and can’t afford bank loans or debt financing or may not be getting the same because of anything concrete to show off to the lenders. In such cases, apart from putting in share capital, shareholders also give out loans to the company at fixed interest terms and conditions.
  • We can consider it as a hybrid form of financing, but the financing is of debt format. Interest is fixed but deferred. Repayment is subordinated to another debt financing, if any, but should be paid off before profit distribution to shareholders.
  • Most times, it is the company that is the borrower; however, at times, it is also the shareholder, who needs to borrow from the company. Although this is not considered as the generic meaning of the term, however, it might be considered as a negative shareholder loan from the perspective of the company.
Shareholders-Loan

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How Shareholder’s Loan is Used?

#1 – Working Capital

At times the companies require quick financing for its working capital requirements. For this reason, it may go into a shareholder’s loan format because it needs regularly and that too at a snap of the fingers; otherwise, its day to day operations are hampered. An example being the loan agreement between eBay PRC Holdings (Bvi) Inc. and Tom Online Inc., dated December 20, 2006, as per the archives of SEC.

#2 – Business Operations

At times the purpose of the loan is not specified because there isn’t anyone particular use for the funds. A company might need additional funds, and therefore instead of raising more equity, it prefers debt capital, and therefore instead of going to an outside lender, it asks for the same from its shareholders.

#3 – Expansion

After being confident about the current product lineProduct LineProduct Line refers to the collection of related products that are marketed under a single brand, which may be the flagship brand for the concerned company. Typically, companies extend their product offerings by adding new variants to the existing products with the expectation that the existing consumers will buy products from the brands that they are already purchasing.read more, a business may want to expand into a new geographical region or may want to add another product line so it might want to raise new funds and shareholder’s loan might be a more suitable option because most times it comes with lower strings attached, that is, the loan period is indefinite or there might be no interest on the same at all. An example being the loan agreement between Kunekt Corporation and Mark Bruk, the sole shareholderShareholderA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company's total shares.read more of Kunekt, effective as of October 1, 2007, as per the archives of SEC.

#4 – Debt Refinancing

At times the company wants to pay off an old debt because that it had taken at a higher rate of interest or more restrictive terms and conditions, for this purpose, it requires funds, and therefore it raises a shareholder’s loan, which it might be able to negotiate at a better rate or maybe at the current market rate, which is lower than the old rate. Still, the company doesn’t want to wait longer to go to an external lender.

Shareholder’s Loan vs. Capital Contribution

How does Shareholders Loan Affect Taxes?

Conclusion

Shareholder’s loan is a quick and more flexible form of financing which the companies might raise if they are not able to afford external debt or if they don’t have the time to do so. Further, it is also cheaper form as at times, no interest is charged, and it acts as a long term cushion when sanctioned for an indefinite period. Both the lender and borrower need to be cautious about its tax consequences and the formalities related to the same because the IRS keeps a close watch on such financing for any form of tax evasionTax EvasionTax Evasion is an illegal act in which the taxpayers deliberately misreport their financial affairs to reduce or evade the actual tax liability. This includes using multiple financial ledgers, hiding or representing lesser income, gains, or profits than actually earned, overstating deductions, & failing to file returns. read more practices.

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