Question: I'm thinking about borrowing against my securities to open an art gallery. What are the pros and cons of using a margin loan to finance a business?
Answer: Unlike applying for a business loan from a bank, borrowing against your stocks, bonds and other securities can be a quick and easy way to get startup money. There is no business plan to present, no mountain of paperwork to fill out and no credit check to pass. Assuming that you have at least $2,000 in cash or securities in your account, your brokerage firm will typically lend you up to 50 percent of the value of most stocks, mutual funds and other widely traded securities at rates that are often lower than you'd pay for a loan from the bank. For example, if you own $100,000 worth of Microsoft, your broker will generally allow you to borrow $50,000 on margin. And the interest is usually tax deductible.
A downside, of course, is that any time you borrow money to start a business, you run the risk that your company may not produce enough cash to service your debt. Should you find yourself unable to repay the money you borrowed, your broker would be forced to sell some or all of your shares to satisfy your debt.
Borrowing against your stocks and other securities carries another risk. If the price of your stock declines, your broker may ask you to deposit additional funds in your account, which is known as a margin call, to maintain the firm's minimum margin requirement. If you can't come up with the necessary money in time, your broker will liquidate your securities, possibly triggering losses and unfavorable tax events.
"Borrowing against your stocks, bonds and mutual funds to capitalize a new business can be a viable option," says Kenneth Shapiro, a wealth management advisor at Merrill Lynch and a former entrepreneur, "but it's not without risk."