The avenue of raising funds by companies through promoters is increasingly gaining popularity in India. Promoters pledge shares to raise capital for the company to finance projects. Often shares are pledged with banks as well as other non-banking financial institutions, which extend loans typically up to 50% the value of the pledged shares. Pledging is positive where the shares pledged to act as collateral to improve the borrowing limit for short-term borrowing or one-off needs. It is not always a safe ride for investors, and some have burnt their fingers in these investments, below are some truths about investing in promoter pledged shares
A Substantial Rise in the Pledged Shares
should trigger concerns, as more than 20% of a company’s equity capital or a promoter's 50% holding is pledged. A correction in stock prices or a fall in share prices can trigger margin calls, which could lead to demand for additional pledging. If the promoter doesn’t have funds to repay the loan or extra shares to offer as margin, the lender can invoke the pledged shares causing a further fall in stock prices. Corrections in share prices often happen suddenly, and leave investors with insufficient time to exit. It is advisable to avoid companies where the promoter pledging has ascended to abnormally high levels.
Promoters Rarely Give Sufficient Information for Pledged Shares
; this happens extensively despite the Securities and Exchange Board of India (SEBI) tightening pledging rules. SEBI made it mandatory for firms to give detail information on pledged shares every quarter. However, promoters often give the reason for pledging as for 'general corporate purposes' which is not enough to evaluate the use of the pledged money.
Several brokers keep an updated database of pledged promoter assets which they share with their clientele with an intention to advise investors of possible hazards and guide them in their investments. However, a lot of investors are not keen on this information and expose themselves to unnecessary risks. With the current market uncertainties and no pledge monitors, investors particularly into capital-intensive infrastructure and real estate stocks, need to maintain keen attention on pledged shares.