A shareholder loan is a debt-like form of financing provided by shareholders. For the purpose of the loan, the Shareholder is treated the same as any other debtor or lender. Usually, it is the most junior debt in the company’s debt portfolio. On the other hand, if this loan belongs to shareholders it could be treated as equity. The maturity of shareholder loans is long with low or deferred interest payments. Sometimes, a shareholder loan is confused with the inverse, a loan from a company that is extended to its shareholders.
The Shareholder is the party that advances money to the Corporation on condition that the Corporation will repay the loan in the future. Owners of privately-held businesses sometimes make loans to or borrow money from their companies. An owner makes a loan to the business when it is temporarily short of cash to eliminate the necessity of going to the bank and seeking approval for a loan or facing a denial. Shareholder loans are essentially just what they sound like – loans from a shareholder or group of shareholders to the company in which they have invested.
A company can write off the shareholder loan interest payments, which is a benefit of going this route. However, if the interest rate charged is below fair market value, the difference between the two is considered income and taxed accordingly.
Applications
This form of financing is quite common while funding young companies with positive cash flows because such firms are still not able to raise debt from banks but need debt anyway to create a tax shield.
The contribution of shareholder loans to a corporation’s capital structure generally relieves the corporation’s debt load and is, therefore, used in leveraged buyouts to manage a degree of leverage.
An owner withdrawing money from a corporation is the most basic example of how a shareholder loan is used. If the withdrawal is not designated as a dividend or a salary, it creates a loan from the corporation to the shareholder.
Shareholders can extend the loan in distressed or near-default situations to save the company.
A shareholder loan is financing provided to a company by its shareholders and represents debt for the business. Although shareholders are tied to the company, the Internal Revenue Service advises that shareholder loans must be given with the same terms that would exist in a loan between two independent parties. This includes having a fair market value interest rate.
