Introduction
Share finance is a type of loan that allows you to borrow against the value of shares in public companies. .
The amount that can be borrowed will depend on the value and liquidity of the shares offered as security. The lender charges interest from day one irrespective of whether or not any money has been drawn down from the amount available
Share finance is a form of secured lending. It can provide a flexible alternative to traditional bank borrowing and has become a popular way for companies to raise capital as an alternative to issuing equity or debt securities.
The share finance market provides short-term funding (usually of a period of 24 – 36 months) on the security of shares in public companies, enabling investors to diversify their portfolios by accessing a wider range of stocks than they would be able to do through conventional financial products.
This flexibility makes it ideal for businesses seeking working capital at short notice, such as:
- Expansion projects
- Dividend payout deadlines
- Repayment of existing borrowings
The amount of money that can be borrowed is subject to the value and liquidity of the shares offered as security. The amount of money lent is usually between 50% and 80% of the market value of the shares offered as security. This is called the Loan to Value (LTV) ratio
The LTV ratio basically shows how much risk you are taking in lending to a company, as this is how much it would cost if your loan were defaulted upon. The lower your LTV ratio, the less risk you take on—and vice versa.
The importance of LTV
So why do lenders care about this? It’s simple: knowing what size loan can be given at what LTV level allows them to gauge whether or not they will make any profit from their investment or whether they’ll lose out on a lot over time.
Some lenders will lend on liquid stocks only, others may accommodate other stocks if sufficient equity is offered as further security in order to protect themselves against any changes in market value prior to the sale of the stock.
The following are some guidelines that you should consider when deciding upon a lending option:
The stock must be liquid. This means that it can be sold quickly and easily. Stocks that are traded on an exchange (such as the Australian Securities Exchange or ASX) generally meet this requirement while other types of investments such as property or shares held directly in private companies may not. Some lenders may allow you to use non-liquid assets if certain conditions are met (e.g., it must have been previously used for collateral).
The company whose stock is being used must be listed on a stock exchange (or otherwise approved by your lender). For example, many banks require their customers using home equity loans for investment purposes to invest only in companies listed on Australian Stock Exchanges because these companies have stronger reputations than unlisted entities and ensure compliance with reporting requirements – which helps protect banks from fraudsters who might try to obtain money without offering proper documentation proving they own what they claim they do.
There are generally no upfront fees for arranging share finance. However, most lenders will charge interest from day one
The rate of interest will be fixed at the outset and will not vary with the amount drawn down. Interest will be charged from day one, even if you have not borrowed any money from your share finance facility, and is charged on the full amount available to you rather than a percentage of it.
Interest rates for share finance are higher than for mainstream bank finance, as lenders do not benefit from any liquidity assistance from central banks, as they do when lending against other assets such as property.
Borrowing costs are generally higher than for mainstream bank finance as lenders need to cover their higher risk and administrative costs.
For example, the average ROCE for listed banks was 16% in 2017/2018, compared with 15% for unlisted peer-to-peer lending platforms.
A flexible alternative
Share finance is a flexible alternative to traditional bank borrowing, giving you access to cash quickly and efficiently. You can use the funds for whatever purpose you see fit, but it’s most often used as an alternative to overdrafts or credit cards when there’s a short-term need for money.
The following benefits make share finance an attractive option:
- No upfront fees for arranging share finance
- No need for a bank account
- No need for a credit check, guarantor or collateral (in most cases)
t’s important to note that not all lenders offer this service; so make sure you ask if they do before signing anything!
Conclusion
Share finance is a flexible alternative to traditional bank borrowing but each lender will have a unique set of conditions, so always make sure you are fully informed before entering into any agreement.