Raising cash against a large shareholding, rather than selling it outright, is a common choice for founders and early investors in listed companies. The financing structure and loan terms, in particular what the lender may do if the share price falls, determine whether the borrower retains or recovers the stake when the arrangement ends.
Why founders borrow
Founders often hold most of their wealth in one listed company, and it can be one of the hardest kinds of wealth to turn into liquidity. Founder shares usually carry a low cost base, so a sale can crystallise a large taxable gain. And the market often reads a founder's sale as information regarding the value of the company, whatever the private reason.
Sales can also be restricted. Lock-ups after a listing can rule out selling for months. In the US, for affiliates selling exchange-listed shares under Rule 144, the volume limit in any three-month period is generally the greater of 1% of outstanding shares of the same class or the average reported weekly trading volume during the four weeks preceding the filing of Form 144. Rule 144 is a resale safe harbour, rather than the only route for a lawful sale, and other conditions apply. A sale also permanently reduces the founder's stake in the company.
Borrowing against the stake, where any lock-up and other applicable restrictions allow it, raises cash while the founder retains economic exposure to the company. Economic exposure is distinct from legal ownership, which can transfer under some structures. How the arrangement ends depends on its structure and contractual terms.
The lender's view
A lender looking at a single large stake would want to know how quickly it could be sold if the price fell, and at what price. A joint investor alert from the US Securities and Exchange Commission and FINRA on securities-backed credit lines singles out concentration: "If your portfolio is concentrated in a particular stock or sector, a single market event could cause your portfolio value to drop precipitously and trigger a maintenance call. Then you might be forced to liquidate your assets at the bottom of the market."
FINRA's margin rule separately obliges brokers to determine "the total dollar amount of credit to be extended to any one customer or on any one security" and to consider higher requirements for individual securities. On a margin account or bank credit line, a single-stock position tends to get a lower advance rate, a higher maintenance level, or both.
Size relative to trading volume also matters alongside volatility, because selling a block many times larger than a day's turnover may require a price discount. Jiangze Bian, Zhiguo He, Kelly Shue and colleagues, writing in The Journal of Finance this year, used account-level data on regulated and unregulated margin lending in China to show that investors sell more as margin calls approach, and that the selling moves prices and spills over to other stocks. The same mechanism can apply to a single large holding, where selling part of the block to meet a call can lower the value of the rest.
Recourse vs. non-recourse
Recourse margin loans and bank credit lines can pair short call windows with liability beyond the pledged shares, depending on the agreement.
If a call is not met, the lender may sell pledged securities under the agreement, potentially without further notice. Under a recourse facility, the borrower can remain liable for a shortfall after the sale.
Non-recourse equity-backed financing can change both the borrower's liability and the time available to respond. EquitiesFirst, which provides financing against concentrated positions to clients across Asia, Europe and the Middle East, describes its facilities as non-recourse. According to its published description, clients receive written notice and a five-day window to provide additional stock following a margin call. A client who chooses not to do so may terminate the arrangement and retain the financing proceeds already received, while losing the shares committed to the transaction. The precise margin trigger and how it is calculated should be confirmed in the agreement. Eligibility and applicable terms depend on the jurisdiction and agreement; the firm limits access to professional, accredited, sophisticated or otherwise qualified investors.
EquitiesFirst describes a sale-and-repurchase structure under which legal title transfers to the firm for the term. The shares form part of its proprietary portfolio, which it may trade, and an equivalent number of shares is returned on repayment. This makes the firm's ability to return equivalent shares a counterparty risk for the client; retaining economic exposure does not mean retaining legal ownership throughout the arrangement.
Non-recourse terms do not remove the risk of losing the shares. Under either structure, an unmet call can lead to liquidation or loss of the pledged shares, depending on the agreement. The structures differ in the notice and response time available, the options for providing collateral or repaying, and what the borrower owes once the shares are gone.
Before signing
Several questions should dictate the decision to finance against equity holdings. How large is the position relative to the stock's daily trading volume? How long does the lender allow to meet a call, and can it sell without notice? Can it reclassify the stock as ineligible mid-term? If the collateral is sold for less than the loan, who covers the gap? Does legal title transfer, what may the lender do with the shares, and what happens if it cannot return equivalent shares? Tax treatment also depends on the structure and jurisdiction.
These terms do not prevent a loss if the share price falls far enough. They set how much warning a borrower gets and how long they have to respond, which for a founder with one large holding can matter as much as the interest rate.
