Why do promoters pledge shares?

More details are trickling in on the end-use of funds raised through pledging of shares by promoters of companies. Most have pledged their shares as collateral to raise working capital or a term loan, to increase their holding or to fund an acquisition as a multinational had done to buy an Indian company.

In February 2006, Germany-based MHM Group, also known as Huber Group, acquired a 70.5 per cent stake in Vapi (Gujarat)-based ink manufacturer Micro Inks for Rs 1,300 crore (Rs 13 billion).

On Tuesday, MHM Holdings disclosed to stock exchanges that it had pledged its entire stake in Micro Inks. "These shares were pledged by the Huber Group as collateral with its banks to fund the acquisition," said Micro Inks MD Ashwani Bharadwaj. An official clarified that the banks can't sell these shares.

Many others like the promoters of Asian Paints, Ashwin Dani and Ashwin Choksi, pledged their shares to raise their holdings in their respective companies. Dani and Choksi pledged 14.98 per cent of their stake in Asian Paints to increase their holding in the company from 40 per cent to 50 per cent.

On Friday, UTV Software disclosed that three of its promoters, including Rohinton Screwvala, MD & founder, have pledged close to 23 per cent stake in the company. In an SMS response, Screwvala said the money raised by pledging the shares had mostly been used to fund the "two tranches of warrants into UTV."

However, Walt Disney, which holds close to 60 per cent stake in UTV Software, has not pledged any shares.

In August 2006, UTV shareholders approved the issuance of 19,49,360 warrants to be converted into as many shares at Rs 192.50 within 18 months. UTV allotted 519,500 equity shares on February 20, 2008 and 1,429,860 equity shares on March 4, 2008 at a price of Rs 192.50 per share on conversion of the warrants.

Following the share-pledging announcement, shares of UTV Software fell by 14 per cent to Rs 211 on the Bombay Stock Exchange before recovering to close at Rs 226, down 7.57 per cent.

Most other promoters have pledged shares to raise working capital or bring in new investors. Take Kolkata-based Kitply Industries, the plywood firm, which disclosed on Wednesday that its promoters had pledged 35.19 per cent of their stake in the company. "We have not raised any funds but the shares are pledged with investors, who have put in about Rs 100 crore (Rs 1 billion)," said Kitply Managing Director P K Goenka.

India Debt Management, a group company of Hong Kong-based ADM Capital, infused Rs 120 crore (Rs 1.2 billion) for restructuring the company in 2008. The fund was to be used partly to repay the lenders and partly to revive its operations. Kitply had outstanding loans of Rs 500 crore (Rs 5 billion) from about 15 lenders. Many other promoters have pledged shares to just raise working capital for capital-intensive businesses.

The promoters of Dolphin Offshore Enterprises have pledged 30.02 per cent of their stake with banks. "Our business is very working capital-intensive as we need to issue bank guarantees for bid bonds, performance guarantees and warranties. At the same time, we are a low-capitalised company with limited investments in fixed assets,'' said Navpreet Singh, joint MD, Dolphin Offshore.

"To meet our bankers' requirements for collateral for our funded and non-funded working capital, we have had to pledge some shares to the bank. Pledging of shares is not new, it has been happening for almost 15 years now," added Singh.

A spokesman for Ahmedabad-based Torrent Group said, "Torrent Private Ltd had borrowed funds from financial institution for its own corporate purpose for which it has pledged shares of Torrent Power as security. Shares of no other group companies have been pledged.''

On Thursday, Torrent Power had said that its promoters had pledged 21 per cent of their stake in the company.

The promoters of Bangalore-headquartered Kavveri Telecom have pledged 500,000 shares of the company with the State Bank of India. The shares have been pledged with the bank as collateral security for the credit limits sanctioned by the bank to the company, according to an official statement.

The company said SBI Bangalore had sanctioned a credit limit of Rs 60 crore (Rs 600 million) in 2007-08. The company had approached the bank for the credit limit to meet its working capital requirements. The promoters, led by Kavveri Telecom Managing Director C Shivkumar Reddy, hold close to 15 per cent in the company.

Companies are rushing to make disclosures on pledging of shares by their promoters after market regulator Securities and Exchange Board of India made it mandatory. Sebi has asked promoters to disclose details of pledged shares if the same exceeds 25,000 shares in a quarter or 1 per cent of the total shareholding or voting rights of the company, whichever is lower.