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A shareholder loan is a type of lending arrangement between a company and an investor. Loans of this type may be extended by individual investors or by a group of investors. Typically, the structure of the loan provides financing for some company project in return for the receipt of interest payments that are issued according to the schedule associated with the loan. A shareholder loan may be secured with shares issued by the company, or with some other collateral that is agreeable to both parties.
This type of financing is very common in situations involving new companies that have already exhibited the ability to generate a positive cash flow. Since many banks would still consider the new business somewhat of a risk, the shareholder loan fills the void and allows the company to continue growing the business. As part of the terms of the loan agreement, the investor may choose to defer interest payments for a period of time, allowing the business to increase cash flow before addressing the debt obligation.
It is not unusual for the terms of a shareholder loan to provide the company with a long time to settle the debt. This approach benefits the company receiving the loan, in that it is possible to defer making any type of payments on the loan for a longer period than would be possible with a commercial business loan. This in turn allows the business more time to build a clientele and become financially stable before having to make interest payments on the shareholder loan. At the same time, the investor gains the benefit of accruing additional interest the longer that the loan remains outstanding, which only serves to increase the amount of return earned from the venture.
Depending on how a shareholder loan is structured, it may be granted the status of a subordinate loan. This simply means that rather than having seniority in the event that the company enters bankruptcy and goes into receivership, investors must wait until debts with a higher priority are settled before receiving any type of compensation for the amount invested. For this reason, many investors who provide this type of loan require collateral to secure the loan and achieve a higher placement in the settling of outstanding debts. While this approach may or may not result in avoiding junior debt status, associating the debt with a specific asset or group of assets may increase the amount of compensation that is ultimately received from the bankruptcy action.