Thread by @Funter21510910

This post is a crash course on promoter funding, which serves as a bedrock for my next post.

Promoter funding/ financing, is the colloquial term used for raising of debt funds by Promoters of companies usually against the security/ comfort of shares. Thread 1/13

A promoter, many a times, needs money for (a) equity infusion in a new/ growing business, (b) personal use (c) enhancing stake in established business (d) family settlement etc.

If he doesn't have enough cash at his disposal, he borrows from finance firms. 2/13

The most liquid and widely accepted collateral/ security for these borrowings are shares of established (usually listed) companies.

These shares are pledged to the financing firm (or a trustee) to avail of the debt facility. 3/13

The value of shares pledged generally varies from 1.5 to 2 times the amount borrowed. Lower the market cap/ trading volume, higher the share cover.

The borrowing is so structured that additional shares are pledged if share price of the company goes down and vice-versa. 4/13

The lender has the right to sell the shares and recover the monies due if the borrower fails to fulfill the debt obligations on time.

Usually, a notice period of 2-3 days is given to the promoter before the extreme step of disposing-off the shares is taken. 5/13

Shares are very dear to the promoters. Any sell-off could reduce his shareholding considerably which, in-turn, could lead to loosening of his control on the company he owns. Therefore, lenders to promoters, many-a-times are better-off in standing vis-a-vis other lenders. 6/13

Promoter lending is not well accepted by banks since it tantamounts to capital market exposure - an end use frowned upon by RBI. Banks, therefore, don't lend against shares. Mutual Funds and NBFCs, till now, have been the major lenders to promoters. 7/13

Advantages
1. Promoters are able to unlock their capital.
2. Enables entrepreneurial efforts.
3. A very liquid security for lenders that enables recovery within 2-3 days.
4. Enables corporate governance - promoter need not resort to hanky panky related party transactions. 8/13

Disadvantages
1. Rapid movement in share price could erode the security cover.
2. Selling promoter shares may lead to bad blood between promoter and lender.
3. Exiting oversized positions could lead to price erosion, which could result in lower realisations from share sale. 9/13

Special tracking and monitoring requirements at lender's end:
1) Daily monitoring of share price and share cover.
2) Timely intimation to promoter to top-up the shares if share price dips.
3) Monitoring and ensuring that top-ups are done within the timelines. 10/13

Q) How can lenders mitigate risks of lending against shares?
A) By lending against shares -
1. Of companies with market cap of 5k crore and above.
2. Of companies with relatively lower volatility of share prices.
3. With high liquidity/ turnover. 11/13

Apart from the pledge structure (called loan against shares or LAS), the promoters also put to use certain other structures.
1. Borrowing against promoter guarantee.
2. Borrowing without pledge of shares but agreeing to keep a certain no. of shares unencumbered at all times.12/13

Promoter companies that borrow, usually do not have any other source of revenue except dividends. Hence, this type of funding cannot be a cash-flow based funding. Facilities are usually refinanced on the date of maturity. 13/13

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