Pledged shares: Overview, definition, and example
What are pledged shares?
Pledged shares refer to shares of stock or equity in a company that are used as collateral for a loan or other financial obligation. When shares are pledged, the shareholder grants the lender or creditor the right to seize the shares if the borrower defaults on the loan or fails to meet other contractual obligations. Pledged shares do not transfer ownership of the shares to the lender; they remain in the ownership of the shareholder, but the lender has a security interest in them. The arrangement is often part of a secured loan or financing agreement, providing the lender with added assurance that they will be repaid.
Why are pledged shares important?
Pledged shares are important because they provide lenders with collateral, reducing the risk associated with lending money or extending credit. By using shares as collateral, a borrower can potentially secure a loan or favorable terms that might not otherwise be available if unsecured. For shareholders, pledging shares can be a way to access capital or financing while maintaining ownership of the underlying shares. However, it also carries the risk of losing the shares if the borrower fails to meet the terms of the loan.
In the context of business transactions, pledging shares is a common practice in corporate finance, particularly when a company or individual needs liquidity but does not want to sell or part with valuable equity holdings.
Understanding pledged shares through an example
Imagine a business owner who needs capital to expand their operations. The business owner owns a significant number of shares in the company but doesn't want to sell them. They approach a bank for a loan, offering their shares as collateral. The bank agrees to lend the business owner $100,000, and in return, the business owner pledges 20,000 shares of their company. If the business owner defaults on the loan, the bank has the right to sell or take ownership of the pledged shares to recover the outstanding debt.
Another example could be an individual who wants to take out a personal loan and pledges 5,000 shares of a publicly traded company they own. The lender agrees to the loan with the understanding that if the individual fails to repay, the lender can seize and sell the pledged shares to cover the debt.
An example of a pledged shares clause
Here’s how a pledged shares clause might appear in a loan agreement:
"As collateral for the loan, the Borrower agrees to pledge [insert number] shares of [Company Name] to the Lender. These shares shall remain in the Borrower's ownership but are pledged as security for the loan. If the Borrower defaults on any payments or fails to meet the terms of this Agreement, the Lender has the right to take possession of the pledged shares and sell them to recover the outstanding debt."
Conclusion
Pledged shares are a commonly used form of collateral in secured lending arrangements. They provide lenders with a security interest in the borrower’s equity, offering assurance that the loan can be repaid or recovered in case of default. For borrowers, pledging shares allows them to access financing without selling their ownership in the company, but it comes with the risk of losing the pledged shares if the loan obligations are not met. Understanding the implications of pledged shares is crucial for both parties in any lending agreement involving equity collateral.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.