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Can We Pledge Our Shares?

Family business shareholders are often rich on paper but cash poor. One way to raise funds for personal emergencies or new business ventures is to borrow against the shares --from the business or from a bank. Is that a good idea?

 

Shareholder Manager
Why shouldn't I be able to borrow against my shares? I need the money. We're not in the lending business.
Besides, where do we draw the line?
What if other shareholders, or even employees, ask the same?
Then I'll pledge my shares at the bank.
Will the business guarantee them for me so I can be sure to get the bank's approval and a decent interest rate?
It may seem inconsequential to guarantee the loan to you at the bank,but it isn't.
If you default, we have to come up with the money to buy back the shares.
The business can't plan for that.
Then what good is it to own the shares? We do have a redemption plan, but we hope you'll keep your shares.

Whether or not to allow the pledging of family shares is a difficult, two-sided story. Different family businesses deal with the issue differently. Some are very willing to guarantee the loans; others do not.

We don’t think borrowing from the company is a good idea. Doing so makes it difficult to plan for cash flow. It also suggests a paternalistic culture and can blur the lines between business and family.

On the other hand, borrowing from a bank is more of an arms’ length transaction, except for a bank’s typical requirements that the business guarantee the shares. Guaranteeing the shares is less risky to the business, of course, if it has enough unused debt capacity in case it must redeem the shares.

The real issue, then, is less a difference of opinion between shareholders and managers, and more a matter of family philosophy.

Frequently, in our experience, once a shareholder begins borrowing significant funds, it’s usually just a matter of time before a need arises to sell those shares to raise more money. If it’s a personal emergency, the family may choose to have a special family provision.

Some families believe that the best way to keep the business in the family in future generations is to encourage family members not to see the shares as having cash value. Instead, the shares are held for the benefit of future generations. Then, too,keeping shares more equally owned throughout the family is a real advantage.

So, our view depends on the family’s time horizon and its commitment to long term family ownership. If the company will go public or be sold in the foreseeable years, guaranteeing a shareholder’s bank loan makes sense and really just facilitates the eventual IPO or sale.

But if the family is resolved to hold the shares for future generations, then lending money against the shares should be discouraged. Regardless, a shareholder redemption plan should be in place to insure that no one feels locked in against their will.

 

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