By Vishweshwar HS, www.showmytrade.com
Promoters and the majority shareholder group, through their directors, manage the day-to-day affairs of a company. They continuously plan for both short-term and long-term finance for the company. Apart from this, the promoters also have capital requirements – a personal need, money for significant acquisition of another company, or the other holding companies.
The promoter has the option of taking the loan on their shareholdings. They pledge their shares as collateral security for taking a loan from the lenders. For the promoter, pledging is one of the accessible sources of raising the capital.
The pledging of shares is significant factors to check before investing, usually many investors overlook. A high pledging of shares needs more further investigation for the investors/traders.
Why Promoters Pledge their Shares?
Share pledging is one of the methods of accessing funds for companies. The promoters use share pledging to raise capital by keeping the ownership of the company (without diluting their equity). The promoter can monetize their shareholding.
Usually, the pledging of shares is the last option for the promoters to raise funds. The thought is comparatively safer to raise funds than through equity or debt. If the promoter pledging shares also mean that another avenue of raising capital is exhausted. Promoter Pledging of the shares usually a better option when the share price of the company in the continuous uptrend.
When is the pledging of shares risky to the shareholders?
In a secular bull market, the pledging of shares seems a great idea. General investors’ sentiment is in the upbeat.
Share pledge can be troublesome for a company at the downturn of the company share price; promoters need to maintain the value of the collateral all the time. They need to provide additional shares to lenders when the stock price falls, or value erodes. In case promoters fail to bring the additional shares, lenders can sell the shares in the open market to recover their money. Selling of the promoter’s share can lead to a reduction in the promoter’s shareholding in that company. Further value erodes in the stock due to more supply of additional shares in the market. This change can bring new equation as new management can take over the company as a change in the shareholding pattern.
Let’s take one example,
Mr. Shivkumar, a promoter pledges his shares for Rs 100 crores loan, his company’s current market price is Rs 100/-. If the share price falls by 25%, now Mr. Shivkumar’s collateral value becomes Rs 75 crores. Now he has to bring in additional collateral (which is called “Margin Call”) of Rs 25 crores. If the promoter is unable to arrange the margin calls, the lender will sell the shares in the open market to cover their money. As a result of its massive supply of shares hit the market shares price will drop significantly.
The news of lender selling in the open market, panic set in, the stock price of the company will erode significantly in a short period.
Any retail investors struck in this stock will considerably lose his portfolio value. Usually, the stock will take a more extended period to return its previous high. Not just that, at times, the new entity may also buy the stock as promoter lose control of his company.
Share pledging is a popular way of accessing funds for companies by promoters, but bitter experiences in the past need a careful study. Share pledging also signals poor cash flow patterns, the credit crunch, and the promoter’s ability to meet short-term working capital requirements. The promoters often make such share pledges for personal needs as well.
How to find the pledging of shares information for Indian companies?
India’s securities market super boss, Securities and Exchange Board of India (SEBI), has formulated specific rules and regulations on appropriate disclosure of such borrowings after the Satyam scam that broke in 2009.
The information about the pledged shares can find out easily on www.nseindia.com and www.bseindia.com. Search under Promoter Pledge details. You can also browse www.moneycontrol.com and www.screener.in etc. for the pledged shares information by the promoter.
Pledging of Shares – Rule of Thumb
We can see promoter pledging of shares in the companies where the shareholding of the promoters is as high as 80%. Typically, pledging of shares above 50-60% can risky for the small retail investor. Kindly study the pledge percentage of a company by the promoter. It could be better for a long-term interest in the company. But, generally, it is advised to ignore companies with high pledging of shares to avoid the unnecessary risk involved in investing such stocks.
The practice of shares pledging is high in a company where the promoter owns a significant stake in the company. Pledging of shares is not always a lousy situation for all the companies. The promoter can also deploy the realized amount for increasing operating cash flow and good prospects.
During the downtrend of the economy or any specific company situations (where lenders start to sell the stocks of the company), pledging of the shares by promoter could influence serious consequence for the share price. The retail investor should navigate the information to avoid significant investment disaster.
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