Every startup wrestles with how to secure funding, and lenders like Equities First Holdings LLC are exploring creative alternatives. When applicable, stock loans are a smart way for many entrepreneurs to fund a business.
In the early stage of a business, it’s important to hold on to equity. Venture capital isn’t the right option for every new business. In fact, it’s not even one of the 5 most common funding sources, which include credit cards, personal savings, friends and family members, retirement accounts and micro loans.
Global micro loans total over $38 billion and have been borrowed by over 74 million entrepreneurs. These loans are issued to those who would not qualify for a bank loan because of low income or poor credit, which drive up their interest rates. According to Kiva, an online lending platform, the average micro loan interest rate is 35.21% annually.
Most startups struggle to make money immediately. Add a large interest rate payment and that increases the pressure on the business to succeed.
Stock loans provide a lower-interest alternative. Equities First Holdings LLC conducted a lending survey in 2012, asking 400 finance officers at public companies if they would recommend a stock loan. 57% said they would.
According to Equities First, “a stock loan uses equities as loan collateral for a typical period of three years. For example, an individual has stock in Company X and believes the stock will appreciate in the coming years. Rather than liquidate his position in Company X, the shareholder transfers the shares to the lender and receives the loan proceeds. One of the most important features of a stock loan is the security that it brings. If Company X’s stock appreciates during the loan term, the individual retains 100% of the market value at maturity.”
In simpler terms, a business’s stock is used as collateral to receive a loan. The loan recipient does not have to sell their stock. Instead, the lender holds on to it while the loan is being paid. Margin loans are in the same family but are not the same thing as a stock loan. Equities First Holdings details the difference between stock and margin loans in an infographic that also examines how a stock loan would work in possible scenarios.
Providing stock as capital drastically reduces the interest rate. Average interest rates on a stock loan are between 3% and 7% annually. For those with stock to offer as collateral, it becomes a more appealing option than a micro loan above 30% annually.
If the stock assets increase in value during the loan term, they don’t go to the lender. The business owner gets to keep those gains. Likewise, if assets go down, the business doesn’t default on the loan.
Liability can also cause major concern for potential loan recipients. There is no personal liability in a stock loan. The lender’s only recourse is the agreed upon assets in a portfolio.
Any funding source comes with risks. Responsible lenders like Equities First Holdings LLC make people aware of the benefits, risks and expected outcomes.