Last week’s article was about securing your shareholders loan. Now let’s focus on securing your retained earnings. The retained earnings, share capital, and shareholders loan represent your entire investment and are often a family’s largest asset. Assess the risk of financial adversity, lawsuits, environmental exposure and other unforeseen catastrophic events. If your retained earnings – ie. undistributed profits – warrant, you should secure them.
The process is more complex than securing a shareholders loan. The oversimplified version is:
1. Incorporate a holding company (Holdco).
2. Transfer ownership of the operating company (Opco) to Holdco.
3. To the extent allowable, pay a tax-free dividend to Holdco.
4. Lend the money in Holdco to Opco.
5. Secure Holdco’s loan to Opco.
To the extent of the dividends from Opco to Holdco, the retained earnings have become a secured debt of Opco. If a financial catastrophe occurred, the loan would be paid after the bank and after other secured creditors but before any unsecured creditors. Prior to this reorganization, shareholders would only get paid if all other creditors were paid. The costs, while not prohibitive, may deter owners where either there are insufficient retained earnings or the risk of financial catastrophe is so low as not to warrant the cost.
The reorganization will require the assistance of your accountant and lawyer. Consult with them prior to taking any action. If you have any questions, please contact us at 204-942-0300.
A word of caution: while the process is relatively straight forward, it is legal and technical in nature. Professional advice should be sought before implementation.