Loan stock definition
/What is Loan Stock?
Loan stock is shares in a business that have been pledged as collateral for a loan. This type of collateral is most valuable for a lender when the shares are publicly traded on a stock exchange and are unrestricted, so that the shares can be easily sold for cash. This collateral is also more valuable when the traded price of the stock is relatively consistent over time, so that the lender does not have to worry about a price decline impacting the value of its collateral. This arrangement is of less use when a business is privately held, since the lender cannot easily sell the shares.
The lender may require that it retain physical control of the shares for the duration of the loan, and will return the shares to their owner once the loan has been paid off. If the borrower defaults on the loan, the lender can then retain the shares.
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Disadvantages of Loan Stock
Loan stock can be a problem from a corporate control perspective, since a loan default means that the lender acquires the shares, and therefore the related ownership percentage in the business, along with all associated voting rights. This can be a particular problem when the lender has entered into the loan with the intent of taking control of the borrower.
A loan stock arrangement can be risky for the lender, since the market value of the shares being used as collateral may decline. When this happens, the collateral may be insufficient to provide complete coverage for the remaining loan balance. If a portion of the loan principal is being paid back on an ongoing basis, this is less of a problem, since the loan balance will be declining over time. If the loan is being paid off incrementally, there may be a clause in the lending agreement under which some portion of the shares are returned to the borrower before the end of the lending arrangement.