Entrepreneurs that own corporations have probably heard of a holding corporation. This is phrase that most business minded individuals are aware of. It is known as Holdco. This is something that works well for some people and doesn’t work well for others. What is it? Do you need to consider it?
A holdco is basically a corporation that is incorporated in order to hold something. Usually it will hold shares in an operating corporation. Holdco’s should not be used to hold assets, which could make it more of a liability than anything else. The main purpose of a holdco is to protect a larger corporate entity.
The Relationship Between a Holdco and an Operating Corporation
The holdco is basically like a “bank” for the operating corporation. Cash is moved from one company to another via inter-company dividends. In Canada, the good news is that these dividends are generally considered tax free.
The Relationship Between a Holdco and the Shareholders
If a holdo is properly structured, then the shareholders will be paid in two different ways. They will basically receive dividends from the holdco as employees of the operating corporation. The owners can contribute to the CPP, which gives them tax breaks on the dividends that they receive. Some holdco structures even allow the family members to receive shares as well. Owners are given voting shares, and family members are given non-voting shares.
Basically, the directors of the Holdco can pay dividends to the shares depending on the shareholder’s tax bracket. This is also called dividend sprinkling. It is a safe way to ensure that family members are able to get money without having to hire them.
Why Consider a Holdco?
Holdco’s can be ideal for some businesses. It is mainly used by businesses that have a lot of cash flow, but also have a high risk of liability. Why would a business that has a lot of potential liability want to leave a lot of their cash sitting around? Moving it to a holdco could be the best option.
Why You May Not Want a Holdco
While there are good reasons for opting for a holdco, there are also reasons that you might want to avoid it. After all, if an operating corporation is sold, the holdco is not going to get any exemption on the capital gains. Sometimes, the structure can be collapsed before this happens but it can be quite costly. Another thing to consider is the cost of administering a holdco. There are a lot of costs involved, because it is much like having two businesses instead of one.
The Bottom Line
Holdcos may be a great idea for some businesses, but they can also be very complicated and expensive. Most entrepreneurs should discuss this option with their advisor before they decide if it is right for them.