Pledged Shares refer to shares that a company's promoters use as collateral when seeking to raise funds or secure a loan for various purposes, such as working capital requirement, funding for the business, or raising funds for any new projects as well as for personal requirements.
In this arrangement, the shareholder (pledgor) pledges their shares to a lender (pledgee) as a form of guarantee for the borrowed funds. If the borrower fails to repay the loan, the lender can take ownership of the pledged shares as a means of recovering the outstanding debt.
Here are key points to understand about pledged shares:
Collateral for Loans: Pledged shares serve as collateral to secure a loan. It assures the lender that if the borrower defaults on the loan, the lender has the right to take possession of the pledged shares.
Ownership and Voting Rights: While the shares are pledged, the ownership remains with the shareholder. However, the pledged shares might come with certain restrictions, such as limitations on voting rights or the ability to sell the shares without the lender's consent.
Value of Pledged Shares: The value of the pledged shares is a crucial factor in determining the amount of the loan that can be extended. The lender may only provide a loan up to a certain percentage of the market value of the pledged shares.
Market Fluctuations: If the market value of the pledged shares declines significantly, the borrower may be required to provide additional collateral or repay a portion of the loan to maintain the agreed-upon loan-to-value ratio.
Enforcement of Pledge: If the borrower defaults on the loan, the lender can enforce the pledge by taking possession of the pledged shares. This process involves selling the shares to recover the outstanding debt.
Regulatory Disclosures: In many jurisdictions, companies are required to disclose information about pledged shares held by promoters or major shareholders. Such disclosures are aimed at providing transparency to investors about the potential risks associated with pledged shares.
Impact on Stock Prices: Large-scale selling of pledged shares in the market, especially by promoters, can sometimes lead to a decline in the stock price of a company. This can be a concern for investors and may attract regulatory attention.
Pledging shares can have both advantages and disadvantages. Some of the advantages of pledging shares include access to additional funds, no tax liability, retaining ownership, dividend income, and flexible terms.
However, there are also some disadvantages of pledging shares, including risk, price volatility, impact on stock attractiveness, and haircut percentage.
If a borrower fails to repay a loan that was secured using shares as collateral, the lender can sell the shares in the market to recover the amount owed, which exposes the borrower to the risk of losing their shares.
Higher pledging can be considered a risk factor, impacting the stock’s attractiveness. Overall, pledging shares can be a useful tool for accessing capital, but it also carries inherent risks, and borrowers should carefully consider the terms and conditions before pledging their shares.
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