Pledged Shares Meaning Example How Does It Works

Pledged Shares Meaning

Explanation

Promoters of the company pledge shares & uses shares as collateral security for getting a loan to meet the business requirement or personal fund requirements. For business, the loan can be taken to meet the working capital requirements, loans for acquiring new business, starting new projects, and acquiring assets. It is different for the hypothecationHypothecationHypothecation is a process where a lender receives an asset offered to him/her as collateral security. It is done mainly in assets that are movable in nature to establish the charge against collateral security for a particular loan.read more of assets. In pledging of shares, shares will be in the promoters’ name, but they will be transferred to the bank as security of the loan. Till repayment of the loan, promoters can’t transfer ownership of shares. It is only preferable when promoters are assured about future performance and inflow of business, and with that inflow, they can repay the loan.

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How do 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 considerably less than the value of shares as of that date because the market is dynamicMarket Is DynamicMarket Dynamics is defined as the forces of market constituents responsible for the shift in the demand and supply curve and are therefore accountable for creating and reducing the demand and supply of a particular product.read more and unpredictable. In the case of a bank and a financial institution, different lenders have different rules and the rates at which they provide the loan based on the market value of the shares.

As we know, the market is dynamic and unpredictable. So one cannot predict whether the value of pledged shares will rise or fall in the future. So, to ensure that the lenders have enough security against the loan, they provide clauses or terms & conditions in their contract with the promoters. Promoters have to give cash or pledge more shares if there is a fall in the market value of the shares. In case of a 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 pledge 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 to sell 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. If the market value of the shares falls from that minimum recoverable amountRecoverable AmountThe recoverable amount of an asset is the present value of the expected cash flows that will result from the asset’s sale or use, and is determined as the greater of two amounts: the asset’s fair value as reduced by related selling costs, and the asset’s value in use.read more, then the lender may sell the shares in the market to recover the best possible amount. In case this scenario occurs, then there are chances of a fall in the market value of that company as the stakeholders may become insecure about 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 why it is considered the last resort for the company.

Example of Pledged Shares

ABC Limited is a public company listed on a stock exchangeStock ExchangeStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ.read more, and is a reputed company in the market. The market value of ABC limited is Rs.10000 million. Promoters of the company hold 60 % of the total holding. Total equity shares of the company are 100 million shares of Rs. 10 each. Promoters hold 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, the promoters are thinking about diversification. They want to acquire new business, and for acquiring new business, they require funding of Rs. 5000 million. Non-current assetsNon-current AssetsNon-current assets are long-term assets bought to use in the business, and their benefits are likely to accrue for many years. These Assets reveal information about the company’s investing activities and can be tangible or intangible. Examples include property, plant, equipment, land & building, bonds and stocks, patents, trademark.read more of a company are already used as security for an existing loan. Still, they can give Rs. 3000 million of funding for their non-current assets (i.e., building, plant, and machinery) as security means a loan of Rs. Three thousand million will be secured on non-current assets. The company’s cash credit is already secured on currents assetsCurrents AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more (like debtor and stock).

As a company is healthy and growing and expects good inflow and performance from a new business, promoters are willing to secure a loan of Rs. Two thousand million by pledging their shareholding. It means promoters give their shareholding as collateral security for Rs. 2000 million loans. For Rs. Two thousand million loan promoters have to give the bank 3000 million worth of shareholding as collateral security. It means promoters of the company will give 30 million shares having a market value of 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.

Conclusion

Promoters can pledge their shares to get funds for business or personal requirements. The company considers this method a last resort for availing funds from lenders. The company doesn’t prefer to give shares for security because that can affect the company’s goodwill. The company keeps this as the last option for funding. First, they prefer-current and current assets to give as security for raising funds, and if all the assets are already given as security to a bank or financial institutionFinancial InstitutionFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more, then they try to get the unsecured loan based on business and their goodwill.

But if the company is healthy, growing, and expecting good inflow in the foreseeable future and is in a condition of repaying the loan installments timely. It can raise funds by giving shares as collateral security against the loan amount.